Saturday, September 25, 2010

Why Football Clubs are poorly-run Media&Entertainment-focused Venture Capital Funds


For many decades one of the biggest problems faced by Emerging nations was the brain drain. To the extent that these countries had reasonable tertiary educational facilities and/or had invested in their brightest students and scholars (so that they could study abroad at prestigious top universities), the big problem was that a large percentage of those people did not return.

Things are improving. First, financial growth and incomes in Emerging countries increase much faster than in developed ones. And although the income gap is still large - higher growth from a lower base does not immediately catch up with lower growth from a higher base - future
prospects and huge dynamics do change things. The most entrepreneurial talents do now find opportunities to stay, start a firm or join as partners and 'create' themselves a brighter future.

One sector that struck us as always being in the news negatively when it comes to finances is the sports world (and to a lesser extent other parts of the entertainment world). Although we see that on the one hand revenues related to entertainment are growing everywhere, including
those in sports, the number of sports clubs (almost) collapsing under huge debts is growing. Why is that?

An example: Good old football

Let's take the football world as example. Although football (soccer) is still relatively small in the biggest entertainment market of all - the USA - it is in the rest of the world the most important component of this sector. Brands like Manchester United, Real Madrid, FC Barcelona, Inter Milan, Bayern Munich etc are technically large 'firms' with super brand value. Sometimes large enough to issue shares and be stock-market listed (see the chart below). But in most cases they seem to struggle when listed. OK, the chart presented here shows nice growth - especially for London-based Tottenham Hotspur -, but who didn't show nice numbers between 2003 and 2008.

One of the problems is that the football world is still dominated by management structures related to how football clubs were organized in the amateur zone: volunteers plus people from the local community with 'high prestige'. But being a visible notary or lawyer in the local
Rotary does not make you a good CEO/Chairman of an entertainment firm. Actually: if anything, we would link the sports world to the entertainment world. Rather have the Oprah Winfreys or Mark Zuckerberg's of this world run a club like Ajax Amsterdam or ManU than people that
are too often there for what we can euphemistically call 'indirect reasons'. Even when I am a big businessman with a firm 100 times bigger than a famous football team, my prestige goes up indirectly via the football team whose brand is so much bigger and more visible than my
own. After that, the businessman can try to earn from that exposure in his own firm. Technically: using the club as a bicycle with him being the bicycle racer, but participating in a different Tour de France!

Also: although big football teams with huge brand names have become truly 'professional' in terms of how they SHOULD BE run, way too often -when looking at the management structure - they are ran by part-timers. Like the chairman in our previous example. As often as possible at the club to be visible when there is a match, but during the week making the money in his own
firm. True, there are full-timers in the management of those clubs. But they are most of the time of similar quality as the people who work for political dictators. Half the time busy telling the chairman how fantastic he is and the other half of the time trying to fool critical journalists and/or worried fans.

Underestimating the Finance Function

One area that is always hurt most by this kind of leadership structure is finances. CFO's or director of finance roles are the type of roles where one has to be 'finance savvy', know about accountancy, investments etc. Yep, typically the roles for people who do not fit that well in a trendy entertainment environment. That is probably also the reason why you read dozens of stories about big stars being fooled by their manager/financial adviser.

What to do with that boring Finance Function?

Now, we hear you wonder: what has all this to do with Emerging Markets? Well, just analyze the composition of the best teams in the world and you will see that the bulk of players in the Spanish, English, German, Dutch, Italian or other top clubs is not local. The bulk of the players (later we will see them as 'ventures' in this article, actually the ones that are most attractive from a financial point of view!) are Brazilian, Argentinian, from big African nations, Eastern European etc.

Initially the game was simple: whenever you saw a top player from one of those Emerging countries at the World Championships, at the Africa Cup or even sometimes at Asian Championships - or because you had scouts traveling around those areas - you would simply offer them more than what their local team could offer. Yep: a talent drain similar to the brain drain that we started this article with.

Examples of a talent drain: Drogba (CIV) in England; Messi (ARG) in Spain

Legal changes: Clubs will have to take Finance seriously now!

But the world has changed. Legally there was the so-called Bosman ruling in the football world. Whenever a club sells a football player who still has a contract, the price they can ask for training and 'research and development' added to that player while at the club ('making him a better player') is a kind of goodwill that was previously only a function of supply and demand between one club and another. Actually: in that interplay between clubs and player advisers there were even examples of the clubs and advisers basically thinking about their own pockets and not about the players!

However, one not too important Belgian player - Jean Marc Bosman - went to court stating that this 'supply-demand' play between clubs and advisers technically led to a situation of slavery for the players. 


Exaggerated, of course, because we are talking about people here that are free and make a decent or even rich living, but it is true that a totally free market could hinder the player from finding a job elsewhere. By definition the number of strong clubs is some 20-40 times smaller than the number of good players. And although that might be similar in other industries as well, don't forget we are faced here with a not so transparent, even shady business environment run by 'not-so-professionals'.

Judges decided that there should be some connection between player salaries and transfer prices charged. And this led to increased salary levels. Those players that were not sold for lottery-like prices benefited, increasing the clubs' debt levels but the idea was simple: knowing about the multiplier between salaries of potential stars-to-be on the one hand and transfer prices on the other one or two sold stars would make a living for the top clubs.

Running a football club is like running a venture capital fund

However, in combination with another trend, the growing importance of (international) television and other media rights and the opportunities created through merchandising it also led to a situation in which running a club became more complicated. When analyzing things that were happening without getting excited about the sports or the entertainment: doesn't this all sound like a transition of a club into a media-related venture capital firm?

The business model is now less and less about getting a large enough number of fans into the stadium and more and more about 

a) qualifying for the big international tournaments and scoring the media rights; and

a') working together as clubs to optimize those media rights in terms of value; and

b) having a good acquisition and exit strategy in terms of creating value through the buying and selling of top players (i.e the ventures you invested in and worked on).

The fact that most teams struggle indicates that current management is not good at it. Problems are: the FIFA and UEFA, the world and european federations who both have a bad reputation with fans and pundits, are doing well. OK, they pay a lot to successful clubs and national teams. But when taking into account the value of media rights they don't pay enough! It is similar to what we see elsewhere in the entertainment world. Movie stars are doing well with incredible fees for playing in films, but the Steven Spielberg's and George Lucases of this world do far far better.

So when looking at a') above clubs do not stick together properly and suffer from a below-optimal allocation of created value to them. Be sure that in negotiations between media firms like national television stations, movie theaters and cable providers on the one hand and professional parties like Walt Disney, SKG (Spielberg Kohlberg Geffen) etc on the other the ball game during negotiations about allocation of wealth is a bit more even.

Leaves us with b): adding value via the buying and selling of players. Too many clubs were optimistic or not creative enough as a result of which they did not find the right formula. We know, it is not easy. Just like in investing the average investor cannot beat the market. But as you know, we started this article by concluding that clubs are not so well organized. Technical directors who tend to be enthusiastic about players who they or the trainer want and financial directors who are part-timers spending other people's money too easily, can easily fall for the trap of over-excitement about winning the lottery by selling top players 2-3 years later (or with those players finally qualifying for the Champions League) instead of monitoring cash flows properly. And those cashflows are also related to the monthly payment of salaries. This situation can easily translate into overpaying. Interesting fact: most good books about 'New Media' or business in which new media become more important teach you to properly manage costs. The sky is the limit, but monthly cost levels are far more certain than those skies! A good example is the excellent book 'Net Profit: How to Succeed in Digital Business' by David Soskin (Wiley, 2010).

And that is what is happening. Top brands in 'firms' that are poorly run and plagued by excess debt burdens due to high salary levels, lousy contracts and insufficient value creation via media rights and merchandising. And whereas real venture capitalists understand that their exit strategy is to a large extent not just a function of their bottom-up successes within the fund, but also related to external factors (how is the market environment at the time of potential exit?), football clubs did never seem to really incorporate those external factors in their financial strategies.

What will happen? 

The bottom-line did not change: a growing industry, with a growing role played by star actors from Emerging Countries next to the stars from within the developed world. Can something be done? We believe so. And the answer is threefold:


Finally start structuring the clubs like a true company, and do not compare to regular industries. Compare yourself to venture capitalists who understand the media and entertainment industry. You are basically running a fund in which individual players are the ventures.

The world has changed. A lot of the potential value of merchandising and club brands is in NEW media. The internet. A lot of the fans are in markets that are just now getting online. 1+1 = 3. It is not just about your fans that come to the stadium in your city. It is also about the fans in Asia, Africa, Brazil. But at the moment in sports, too often it seems as if 1+1 =0.5

A few British football clubs know what I am talking about. Just ask ManU management or Arsenal about their 'value' to fans in Asia or the Caribbean & Latin America or elsewhere. In countries without strong competitions people watch the champions league and associate with tons of other teams and top players and not just with those that participate in local competitions. Far more teams or even National Leagues could do something with this globalization of the industry and the growth in new media. But they don't.

The external value of big football brands grows 
in regions they previously did not really think about. The well-run ones do understand this already. And use the fact. The bulk of top 'brands' seems to be ignorant about it.

The CFO who until now was that boring guy that did not really fit into the sky box conversations in the stadium was way too often some semi-volunteering and lower level accountant. Not the type of person to create new financial products. Ad-hoc and occasionally you see clubs create new financial instruments to pay for their new players or for a new business lounge in the stadium etc. Bonds to be bought by fans with lower interest rates and part of the remainder paid through discounts for club cards or tickets for top games etc. Not the whole story, but at least something of a start. Or we see 'securitized' player pools through which a club increases its budget for player acquisitions through financiers who then get a stake in the value of the pool, so that they will benefit as soon as one or more of the players in that pool are sold. Good plan! Actually the idea that clubs should work out themselves when they understand that they are basically a venture capital firm!

Or we see initiatives like the one we wrote about a few months ago. Clubs that try to attract money online. As a fund. With the investors then becoming shareholders. Not too weird. In a way a club like FC Barcelona is still run by the socios. Members who make it a true club and not a firm. But the bottom-line consequences of that idea make it comparable to a shareholder role, albeit that it is in the end not optimal because in a membership structure it is more complicated to run the venture with huge brand name value professionally. At the moment the least it does is add some prudency to the budgeting. But value is not only about costs. It is also about revenue optimization.

Those ideas as more general theme are still laughed about. But there is a lot of potential there. When clubs are like venture capital funds......venture capitalists understand that they need to attract investment capital to do their thing. Some football clubs went public, but mostly at wrong times and with the wrong stories (namely standard ones) and with the wrong advisers. Example: Ajax Amsterdam went public at a time when Dutch bank ABN Amro was a big adviser. But also a typical representative of the old economy, i.e. old financial services. 

Just an example: ABN Amro Bank has less than 300 fans at their FB page. ABN Amro USA less than 400. Combined this huge multi-billion bank has less fans than our little financial services advisory firm! Our number of senior executives is smaller than their number of branch offices in the average Dutch provincial capital! No vision about the New Economy is almost automatically no vision about running a venture capital fund with strong media and entertainment element in it.

Graph 1 above showed the performance of stock market listed firms at the smaller English exchanges. It is from Thomson Reuters and covers the period 2003-2008. Amidst the crisis football clubs collapsed just like others when looking at performance. But one thing strikes us: the clubs that went for this innovative solution are not necessarily the biggest clubs. So far football has been more about collecting debt than about running a firm. And clubs got away with it. But internationally, there is also something else going on. A trend that makes financial innovation and going public something that will grow. And that is the fact that federations do not accept it when one club tries to be solvent and run a prudent household, whereas others add debts, buy the best players and then - when almost bankrupt - run to local and state governments asking for more money telling the authorities that they should do it because of the number of fans they serve or even worse: potential violence when the fans don't have their regular game! That would be like giving a totally wrong signal to those clubs that act in a prudent way. Football authorities have reacted by creating systems that will deduct points at the start of the season from those clubs that do not show proper budgets. An excellent plan.


We are therefore confident that things will change. Either because the next generation leaders will understand more about entertainment and modern media, or simply because they have to. The debt burdens and financial figures will urge them to do something.

What it means for the ventures? For the players, who often come from Emerging countries. Well, to the extent that you can fool your buyer into crazy deals, congratulations. But still: too often they don't realize what their relative value is. Similar to actors versus film producers. With advisers way too often getting too large a part of the cake. So more professionalization is needed at that layer as well.

But the real bottom-line? The sports and entertainment industry will continue to grow. And part of that growth will be a shift towards an industry structure that will allow outside investors in, in a way similar to what is happening in other industries and with chances to participate in healthy growth and good P&L's. The internationalization of the industry through new media will be a catalyst of that trend.

When looking at football, but maybe also other sports or other parts of the entertainment industry, European and US domination might disappear due to this internationalization. Right now the acquisition of old - almost former - stars by clubs from the United Arab Emirates is still seen as 'something funny' and just as unprofessional as what is going on in the European top clubs - just that the (ex-)stars are older and almost retired - is a fact that sometimes being late in an industry cycle might easily translate into an advantage when new trends become important. See also the attached link (Note2) to the activities of Dubai International Capital who tried to acquire an important stake in Liverpool FC.

And that implies that it is not strange when venture capitalists from abroad - and from Emerging Nations - could start playing a growing role. The first signs of this trend are increased numbers of billionaires from Emerging countries who now look at sports clubs to see if they can buy and change them (e.g Abramowitsch at Chelsea). But the next step will be more activist and organization-like entities that will truly reform clubs and business models. Is the idea of a new Chinese commercial television station setting up an entertainment fund to acquire stakes in sports clubs and entertainment activities from Europe or the US so as to bring to their market 'fantastic sports and entertainment at levels previously not seen in China' in an effort to attract more consumers to their channel totally weird? We don't think so. The money is there, the openness to new (financial) developments and business models is there and the incorporation of new media in a strategy is there as well.

And we are not sure if the local, European or American entities will win this battle. A lot of the bigger Emerging markets have growth figures for media business that are simply not comparable to what domestic players from the US or Europe could think of. Therefore: entities from Emerging countries that love football will be next in this rat race. But maybe we are writing this piece 3-5 years too early.

Will be continued....

Note: To illustrate how new trends are, we attach a piece written on venture capital entering the sports world. It is just 2 years old. Click here for the article. 

Note2: And see below a piece about Dubai International Capital who were discussing with Liverpool FC to acquire a stake in that firm already back in 2006. It did not materialize but it is indicative of the changes we write about.

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