• Key takeaways:
• Football industry generally exhibits high risks due to the unpredictability of sports results leading to highly volatile revenue and cash flow generation.
• Smaller football clubs face numerous risks threatening the sustainability of their business model.
• It is highly likely that the majority of smaller football clubs will have severe difficulties securing external financing, even with the short-term maturities.

General risks affecting creditworthiness of football clubs

Unpredictability of sports results is the key obstacle to achieving a strong credit rating for any football club

Anyone who has ever tried to predict the outcome of a sports match knows how difficult that task is. There are many factors influencing the result, one of them being a pure luck. When talking about football, anything can happen not only during one match, but also during the entire season – injuries or suspensions of key players, lost points due to missed important penalty kicks, a streak of weaker results ending in a point – or even worse – slightly weaker goal difference which costs a team a place in the UEFA Champions League, etc. All clubs will be affected by the inconsistency in results in the medium term, and this inconsistency is the key obstacle to achieving a strong credit rating for any football club.

The European league systems, both national leagues and continental tournaments, are based on promotion and relegation systems, meaning that clubs participating in leagues can be relegated to lower divisions if they occupy a relegation position in the rankings at the end of the season. Contrary to the organisation of the US league systems where the clubs do not get relegated, the European clubs are exposed to higher volatility both in sports and financial performance. In case of relegation or underperformance, broadcast figures decrease dramatically, attendance figures and commercial revenue drop as fans and sponsors lose interest, and the value of players often decreases. The best players could even potentially leave the club on a free transfer in case of relegation.

While the relegation risk may not be the same for all teams as financially stronger clubs have historically managed to avoid the relegation, there are no guarantees. In addition, it is not only about the relegation risk, because clubs failing to qualify for international competitions often suffer financially too. There are many examples in the recent past of once big and famous clubs now playing in lower divisions or significantly underperforming, like Schalke 04, Werder Bremen, Hamburger SV, Manchester United, Valencia, AS Roma, Olympique Lyon, Girondins Bordeaux, Galatasaray, etc.

Having the above in mind, it is easier to understand the logic behind the idea of establishing the European Super League recently initiated by several big European clubs. The idea was to introduce the closed league system which would help reduce financial volatility to its members. No surprise that the idea was supported by financial sponsors as such closed system could create a new relatively stable market for financiers.

Limited value of available collateral

When applying for a loan, football clubs often have to present a collateral, just as many other businesses. Normally, the most valuable assets they possess are a football stadium and ancillary sports facilities. Given the lack of alternative uses of such facilities, their value to lenders is highly limited. Even if the location of the facilities would be favourable for transformation to other uses, like building a residential area, it would likely include sizeable deconstruction costs which means the loan-to-value could be highly limited. In addition, one should not underestimate the difficulties of getting in the possession of such facilities in case of a bankruptcy of a football club, which could lead to social unrest and affect the reputation of the lenders.

The other valuable assets that football clubs possess are contracts with their players, where the income from the sale of players could be ceded to lenders. However, this collateral has large deficiencies too. Namely, the contracts are normally of a short duration often allowing players to leave on a free transfer, especially in case of relegation. There is also a risk of injury or a significant drop in market value due to a player’s weak performance.

Having said the above, obtaining a loan, even a short-term one, can be a challenging task for a football club. Financial institutions will likely require collateral, and unsecured loans could be reserved only for the very best, if at all.

Can a football club obtain an investment grade rating?

According to the Fitch “Sports Facilities, Leagues, and Teams Rating Criteria”, here are the conditions for a football club to be assigned an investment grade rating:

“To be considered investment grade, a club must demonstrate a strong history of significant sporting success; a very strong fan base both locally and globally; and the capacity to generate strong revenues to allow it to overspend its competitors on player wages, combined with a conservative debt structure and robust financial profile.”

The conditions above clearly limit the number of football clubs able to obtain an investment grade rating. But what’s with the majority of clubs on the other end of the credit spectrum, i.e., with speculative credit ratings?

Specific risks related to smaller football clubs – case study HNK Rijeka and HNK Hajduk Split

Extremely volatile revenue and cash flow generation exacerbated by a high correlation of revenue streams…

The smaller the club, the more volatile its top line and cash flows, mostly due to inconsistency of sports results and a lack of longer contractual revenue streams. It is important to highlight that football clubs have several revenue streams, however, many of them are correlated with the results achieved on the sports pitch. The most important revenue streams for a football club are: (1) player trading revenue, (2) sponsorship revenue, (3) sale of broadcasting rights, (4) merchandising revenue, (5) UEFA financial rewards and solidarity payments, and (6) ticketing and matchday revenue. All aforementioned types of revenue have a similar underlying driver – sports results, hence making it difficult for a lender to gain comfort when assessing the debt service capacity of a football club.

Let’s examine the revenue structure of two leading Croatian football clubs, which are deemed small in comparison to international peers[1], yet with a regular participation in at least the early rounds of international competitions.

…indicating high reliance on the sale of players, and which can lead to extreme and untenable wages-to-sales ratio

The charts above clearly depict the importance of the player trading revenue for both clubs. While Rijeka managed to benefit from playing in the Europa League Group stage on two occasions (in 2017 and 2020) which diversified their revenue sources in those years, Hajduk relied more heavily on the sale of players.

The reliance on the sale of players leads us to another issue. Namely, the players’ and coaching staff salaries are largely fixed, which reduces the clubs’ financial flexibility outside of regular transfer windows taking place normally twice a year. Highly volatile top line can lead to an extreme wages-to-sales ratio, which is a relevant metric both from the credit perspective and for compliance with the UEFA Financial Fair Play rules.

While Rijeka’s wages-to-sales ratio hovered around 45% (with the exception of 2019), when player trading revenue is excluded from sales, the share amounted to minimum 75%, and with three out of five years exceeding 100%, clearly showing Rijeka’s reliance on the sale of players. Similar story is with Hajduk, where the ratio exceeded 100% during the last three years.

Unattractive national league limits clubs’ competitive position

Croatian top football division belongs to the second echelon in the European football, with a limited growth potential. This translates into generally weak position of all of its football clubs, which show the following competitive disadvantages in comparison to their larger global peers:

• Weak franchise vs larger global peers and a small fan base
• Volatile attendance at their football games including modest ticket and ancillary revenue
• Weak demand for media rights due to the league’s relative unattractiveness
• Limited diversity of events and facilities.

Predominantly short-term financing including reliance on owner’s support

Rijeka’s funding is predominantly short-term, with 85% of its balance sheet maturing within less than 1 year. The main financing line has been provided by the club’s owners, however there are no information about the potential subordination. Capitalization is weak with the equity ratio of only 10%.

Hajduk nominally exhibits better financing structure, however its capital has been decreasing rapidly due to generated losses. Although its equity ratio stood at 63% at the end of 2020, perhaps the more relevant metric is the Tangible Net Worth (TNW) ratio, which amounted to only 7%. Namely, Hajduk capitalizes its right-of-use of the Poljud stadium which is owned by the City of Split (Hajduk is not obliged to pay rent on its use). This is another example of high reliance on club’s owners.

Lack of long-term assets exacerbates funding issues Rijeka’s most valuable asset is a loan to related party Stadion Kantrida d.o.o., which owns the stadium Kantrida where Rijeka plays its domestic games. Hajduk’s long-term assets mostly relate to the aforementioned right-of-use of the Poljud stadium. In both cases the clubs do not have meaningful long-term assets which could be offered as a collateral to lenders in order to have access to capital. Such limited flexibility strongly limits smaller clubs’ creditworthiness.

Analytical issues in the analysis of football clubs’ financial statements

Limited relevance of standard financial ratios

Standard financial ratios like Debt / EBITDA, EBITDA margin, working capital ratios, etc. are of a limited relevance for the credit risk assessment of football clubs, especially the smaller ones. Namely, the figures are highly volatile and largely driven by events and irregular activities, debt is often extended only on a short-term basis (if at all), clubs do not have a regular trading cycle and can have only one or very few large customers in a single season given the sale of players remains dominant revenue stream.

So, what should we focus on when analysing football clubs’ creditworthiness? The starting point is always to determine the business risk profile – the club’s competitive position vs its peers, stability of revenue streams, reliance on events or irregular activities, history of managing difficult conditions, the strength of its franchise, ability to keep its key players, etc. Only once we have fully understood its business risk profile, we can proceed to the financial risk profile assessment. The financial risk assessment should focus on the cash flow generation and understanding how much of the operating cash flow can be seen as recurring. Given the inherent volatility of the cash flow generation, it is advisable to look further back into the past to understand the pattern. In addition, the key metric is the club’s liquidity, with the available cash hopefully comfortably covering short-term maturities.

Distortion in reporting periods

Some football clubs follow the calendar year in their reporting (ending in December), while others have aligned their financial year with the football season (ending in June), which distorts the comparability of their performance. Clubs with a December year-end can have more blurred performance metrics because of difficulties linking cash flows to a football season.

Forecasting exercise is extremely difficult

Credit analysis should always weigh more the forecast financial ratios, however, the forecasting exercise for football clubs has proven to be extremely difficult. The major reasons are the volatility of both sports and financial performance, and reliance on events and irregular activities. While certain revenue streams could be reasonably estimated based on the past figures (ticketing and matchday revenue, merchandising) or contracts in place (sponsorship revenue, sale of broadcasting rights), the real challenge is to estimate the player trading revenue (how to predict which player could be sold when and for how much?) and the UEFA rewards (how to predict sports results?).

A quick glance on Rijeka and Hajduk player trading revenue and UEFA rewards in the 2016-2020 period clearly shows the magnitude of their volatility. However, one should not forget the devastating impact of the coronavirus on the whole industry in 2020, which underpins the industry’s sensitivity to event risks.

Different accounting treatment of transfer fees

Although both Rijeka and Hajduk apply the same accounting standards – Croatian Financial Reporting Standards (CFRS), they seem to book transfer fees differently. Namely, Rijeka capitalizes transfer fees paid and amortizes them in line with the duration of the player’s contract, with expenses shown in the amortization line of the income statement. However, Hajduk reports transfer fees paid under the prepaid expenses in its balance sheet, which are transferred to the income statement also in line with the duration of the player’s contract, however, shown under the OPEX line. Therefore, it is of utmost importance to check the applicable accounting policies in order to fully understand the figures. No automation can help with this issue. The question how to account for transfer fees paid leads us to the next point.

Analytical vs accounting treatment of buying football players

Different accounting treatment of transfer fees calls for attention, and once more depicts deficiencies of EBITDA as a metric, not only in this specific industry. Therefore, we advise to look at the adjusted operating cash flow as one of the key metrics. But why is it called “adjusted”? Under applicable accounting rules, transfer fees are normally reported in the investing cash flow, as they are related to the purchase of intangible assets. However, we see player trading activity as a core activity of any football club, hence we treat all purchases and sales of players as operating activities. This means that the adjusted operating cash flow will include both transfer fees paid and transfer fees received.

Can smaller football clubs be good credits?

As we could see from the previous chapters, football clubs are generally high-risk counterparts for any financial institution. Even more the smaller clubs, as they often lack the stability of revenue and cash flows on one side and sports results on the other side.

Here is a recap of the biggest risks affecting creditworthiness of smaller football clubs:

• Unpredictability of sports results including relegation risk
• High volatility of revenue and cash flow generation exacerbated by a high correlation of revenue streams
• Reliance on the sale of players to cover high fixed costs (most notably players’ and staff salaries), significantly reducing the space for error
• Generally weak competitive position due to weak franchise, smaller fan base, modest ticket and ancillary revenue, and weak demand for media rights in relatively smaller and thus less attractive national leagues
• Difficult access to capital due to volatile cash flow generation and limited value of available collateral (if any) forcing clubs to rely on short-term funding sources and external support.

So, can smaller football clubs be good credits?

While there is no clear answer, it is highly likely that the majority of smaller football clubs will have severe difficulties securing external financing, even with the short-term maturities. The exceptions could be smaller clubs in relatively attractive and larger national leagues (Germany, England, Spain, France, Italy), however, the relegation risk might be elevated in such cases. In any case, many smaller clubs rely on external support, be it from the local communities or financial sponsors. As long as the player trading revenue represents the major revenue stream and which is relied upon to cover the fixed costs, smaller clubs will likely struggle to establish a sustainable business model.