Financing the Emirates: how it affected Arsenal.

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By Phil Gregory

This article about the way the Emirates stadium was financed arose from the work being done in relation to the Parliamentary Enquiry into Football – to which Untold Arsenal is presenting evidence.

I have popped all the key information gathered in a table below to make it (I hope) easier to understand.

If you aren’t interested in the factual details however, have a look at the analysis section at the end so you know how the numbers impact on the big questions. To help I’ve highlighted the key points in bold.

To explain the table just below:

Year Net debt (£m) Bank loans (£m) Bonds (£m) Bond rate (%) Debenture (£m) Debenture rate (%) financing costs paid (£m) 2005 153 213.7 n/a n/a 25.2 negligible 3 2006 262.1 284 n/a n/a 25.5 negligible 2 2007 268.2 64.5 255.2 5.3 25.8 negligible 18 2008 318.1 139.3 250.2 5.3 26.1 negligible 17 2009 297.7 129.6 244.9 5.3 26,4 negligible 16.6 2010 135.6 0 239.3 5.3 26.7 negligible 18.2

Net debt is what we owe the banks (and later bondholders) minus cash in the bank.

Bonds function like a loan from a private investor: I lend Arsenal £1000, they pay me a % and repay me at a fixed date. Dead easy.

Debentures are basically bonds for all intents and purposes. Roughly half of ours receive no interest and are repayable in 136 years, while the other half gain interest at 2.75% which is added to the capital. Overall charges are so low that they don’t really affect the bigger picture, so I didn’t list the rates in the table.

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Financing costs paid are simply money flowing out of the club as a result of our financing. It doesn’t include the small yearly repayment of the bonds (it’s just interest and the like).

If you refer to the table throughout as you read I think you’ll see what I mean, and it will save me endlessly citing figures.

Initially, we borrowed a fortune from the bank to start building the stadium. As the project progressed however, the risk inherent in a large-scale construction project like the Emirates inevitably diminished, so it made sense to shop around and get a new, cheaper loan.

That’s what we did with the bond issue in 2007. So in 2006, the club announced we’d issued a bond for £260m, which replaced the more expensive property development and Emirates Stadium debt (lumped together under “bank loans”). The majority of the bonds were fixed rate, so no surprises in there, while about £50m of them were variable. The refinancing reduced our per-year finance costs from £32m to £20m. The £32m was previously capitalised (i.e. it cost us in the future, more on that in the next paragraph) whereas the £20m we pay there and then, so it impacted current profits.

The eagle-eyed will note that in the table, the “finance costs paid” actually goes up when the bond was issued. This was because prior to moving into the Emirates (season year end 2007), we capitalised the interest on the construction loans. What that means is we weren’t paying off the interest as it was due, instead we simply got it rolled back up into the main body of the loan (PIK style). So for example a £100m loan on 10% interest = £10m interest bill per year. That £10m then got put onto the £100m and the banks were happy as it means we pay more money to them next time round (£110m loan with 10% interest = £11m interest bill).

This idea of “capitalising” the interest is apparently normal when you borrow a lot of money to fund a construction project. It makes sense not to impose another charge onto the club until the construction is complete, and the club is getting more revenue in. Dead easy.

So the bonds decreased our overall interest bill, but we were now paying off the interest as it was due, with the decrease in profits that that brings.

Naturally the club weren’t too fussed about this as during its first season. The Emirates could be attributed to around £55m of increased revenue, compared to funding costs of £18m and additional operating costs of £7m, leaving the gain from the new stadium alone during this single season at £30m. Alongside this, 91% of the flats in Highbury Square had buyers lined up by this point, despite construction not yet being completed.

The bonds were issued in 06-07, and by 07-08, property development was moving into its final stages, reflected by the value on the balance sheet of the development rising up to £188m from just over £100m the season before and the agreement sorted to sell 96% of the units. Net debt was still increasing as we went back to the bank for some short term property funding (bank debt was still way below its pre-bond level if you check). Finance charges slightly underestimate the situation, as they don’t include bank loan interest (for property development) that was capitalised (rolled up) to be paid back later as I mentioned earlier.

Even though at this moment we were again borrowing from the banks, they weren’t frightened to lend to Arsenal. If you consider the conditions back then in the both the property market (where we were hoping to make the very money to pay the banks back) and the banking sector (who suddenly were quite keen to keep their money to themselves due to finding a few subprime ticking time bombs on their balance sheets), 6.6% interest represented confidence in the Highbury Square project.

Cash in the bank at this stage was also high at £93.3m, though over £30m of this was untouchable, as it formed the collateral for the bank’s lending to Arsenal. This partly explains the high cash in hand figures we’ve seen in recent years (once you deduct £30m of the cash in hand, and consider the seasonality of our revenues, it’s really not that much for a club of our size).

By the end of 2009, all the flats were built. There had been a few issues in terms of people backing out of deals, particularly companies who had bought large quantities of the flats with a view to selling them on, due to a downturn in the housing market. The Highbury Square loan was now getting paid down rapidly due to strong sales and as you can see it was cleared by the 09-10 accounts.

For the most recent figures, the Highbury Square and Queensland Road developments have been totally sold off. This means that their debts have been completely cleared (£129.6m of them). With only a few units left to be sold, it is likely that they’ll be sold out by the end of the next financial year. All sales are now producing profit for the football, bar the odd negligible legal/transactional fee, money which is made available to the football side of the club. Debt repayments have resulted in net debt falling significantly, to only £135.6m (from nearly £300m)

Only £45.8m of property remains on the balance sheet, while we can roughly estimate that the remaining units will yield around £33m of pure profit, judging from previous sale numbers and revenue figures. There do remain a couple of smaller property developments, but they are relatively minor and not expected to bring in any money in the short term. They will be a future revenue stream, though nowhere near the level of the Highbury flats.

From here on out, we’ve got around £20m of bond/debenture payments, of which around £5m is repayments. It’s all fixed rate and long term, so there are no surprises in store. Low and fixed rates mean even if the Bank of England raise rates in the medium term (likely in my view) we won’t be affected. All in all, the financial future of Arsenal is amongst the best of any football club, especially when you consider medium term improvements in commercial revenues.

Analysis

Money in the bank and transfer spending:

With all the money from the property development now streaming into the club’s bank account instead of the lenders’, cash in hand increased significantly to £127.6m. This figure caused some significant irritation amongst certain supporters, given a perceived lack of investment in the playing squad.

But this figure is slightly misleading: fans must bear in mind this figure is taken at a specific moment in time, so is affected by seasonal comings and goings. I am a wealthy individual the week after my student loan comes in, but less so the week before the next instalment is due, after all. In Arsenal’s case, exceptional season ticket uptake meant the figure was some £14m higher than would have been in the case normally (disenchanted support? Don’t make me laugh), while £31.5m was locked down due to the terms of the stadium debt along with an additional £6.6m for a similar situation in regards to Queensland Road.

Deducting off the untouchable collateral, and the exceptionally high figure for season tickets at that moment in time, and you have £75.5m that I consider a “normalised” figure for cash in the bank, that can be compared to other sides. Now, you can’t simply go out and blow that on transfers, as over the year (even if we forget player purchasing completely) cash in the bank will fall throughout the season due to the nature of the club’s revenue streams and outgoings. So that £75.5m isn’t simply “spare cash”. Much of it will be needed throughout the season.

So let’s say a percentage of it is available for the transfer fee for a superstar. You have to account for their future wages, so future operating profits (and therefore future cash in the bank) will be lower. Moreover, to attract a superstar you may need to break the wage structure by offering them say £120k per week. The true cost of that per year is vastly more than £120k multiplied by 52 (over £6m), it manifests itself in the increased wage expectations of the rest of the squad. Sure, if we signed Ozil, Eboue isn’t going to suddenly decided he is worth six figures weekly, but he may think that he can get an extra £5k or £10k out of the club per week in his next negotiation.

Consider that for all the squad players, and then the super high expectations of our star players and you quickly see how breaking the wage structure isn’t a “one-off” affair. We cannot ramp up spending on players based on one-off revenue streams (the property profits) either, to do so would be more reckless than City or Chelsea, as at least they can rely on a series of cash injections. We have to be covered for the future costs resulting from that transfer, too.

As an aside, with the high number of contract renewals over the last 18 months, the next wage bill will be substantially higher anyway. Caution will be the watchword for the short term, at least until we start benefiting from improved commercial deals.

It is worth emphasising here that repayment of the property debt didn’t come out at the expense of football funds. The property debt was ring-fenced, so it didn’t affect the football club and was solely paid back by funds it generated itself. Even the interest bill from the property side of things was capitalised, so it didn’t eat into Wenger’s budget. That said, the property development is affecting the football side now (positively) as all profits generated went straight back into the football club, so it represented a little gold mine for Arsène Wenger, should he deem it necessary.

Why then, didn’t Wenger spend over the last few years? Frankly, he did. The wage budget is amongst the highest in the league (wage spending dwarfs transfer spending for the vast majority of clubs, so is the surely more important of the two). Secondly, the constant renegotiations to keep players tied to the club certainly cost us, and looking at the accounts the combined fees for transfers and renegotiations have hit £40m on occasions.

Wenger also spent another resource: time. Prior to the bond issue, no part of the Emirates or Highbury Square was costing the club interest just then (it was all being rolled back up). Apart from the need to hold some cash as capital for the loans, until the roughly £20m finance cost of the bonds came to play, the various bank loans weren’t really affecting the clubs profitability. And yet we weren’t spending money. Why?

Because in my eyes we were spending time on developing a squad. If you can afford to blood a Cesc, Clichy etc, why bother spending if you know in time those players will be as good as, drilled in your systems and style (and more loyal) than a 28 year old purchase?

After the bond issue, we had to rein in spending to account for the fact that operating profits needed to be £20m higher than before to cover the bond payments that are deducted after the operating profit figure is calculated. Given we were already spending significantly on player retention (higher wages and renegotiation costs) in order to keep this squad together, transfer spending was purely limited additions when things don’t go as planned. A good example of this is Senderos: he came in as a young player with huge potential and didn’t make it in the end, so we used the scouting system and got a Vermaelen to replace him.

Hence my belief is this: we didn’t spend initially as we sought to blood players and use the academy (we instead spent time). We did this as we couldn’t play the same game as everyone else in the transfer market, and we couldn’t play our original game eternally (sublime performance in the transfer market for low costs: see Anelka, Henry, Vieira). After the bond issue, we had extra charges and our young players were reaching the top level, so we had to pay more to hold onto them. In the Emirates, our revenues went up significantly,but given that the squad by this point was reaching fruition, where could we strengthen? Fans demanded a defensive midfielder in the summer of 2008, yet Song is now one of the best in his position. Last summer they demanded a goalkeeper, now Fabianksi and Szcznesy are playing excellently.

Our old competitive advantage was being wiser in the transfer market. Our new competitive advantage is the academy: we don’t need to go into the transfer market when we are producing Wilsheres that are the envy of some of the biggest clubs in the world.

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