Deals in Focus: Manchester United

For the best part of two decades, Manchester United has dominated the English football scene, winning 11 Premier League titles since 1993, two Champions League trophies, four FA Cups, two League Cups, and the Fifa World Club trophy. But while this success has cemented United’s position as the best-supported sports team in the world, off the field it is another story.

The ownership of the club by US businessman Malcolm Glazer has come under persistent attack from the team’s own supporters and the mainstream press. Despite 10 out of 20 Premier League clubs now having foreign owners, much of the criticism of Glazer concerns how he financed his acquisition, which was completed in June 2005 through the Red Football Ltd vehicle.

Using debt, whether bank loans or bonds, to finance takeovers is hardly a rarity in the corporate world. But the word debt has negative connotations to the average football supporter or sports journalist, so when Glazer raised £509 million through bank loans to help finance the deal it was seen as an immediate black mark in the eyes of supporters. Anti-Glazer demonstrations are commonplace four-and-a-half years after he took over, despite the team’s success.

So when the club (through its subsidiary MU Finance) completed a debut £512 million high yield bond issue to refinance its bank debt on January 22, condemnation of the deal as expensive and risky in the mainstream press was hardly a surprise. But it is telling that many high yield investors and analysts were no more enthusiastic, with one manager of a sterling high yield fund describing the deal as “poorly constructed and poorly priced – an absolute shocker”.

There is also uncertainty about who exactly bought the deal, with the underwriters declining to give Credit a breakdown of the distribution by investor type or geography.

It is known, however, that the borrower conducted an extensive series of investor presentations in Europe, the United States and Asia, where arguably the team is more popular than at home in the UK.

“Perhaps people bought the bond because they were fans of the team,” says Chris Chaice, an analyst at the independent research firm Covenant Review.

Completed on January 22, the unrated deal was divided into sterling and US dollar tranches, both due to mature on February 1, 2017. Bank of America Merrill Lynch, Deutsche Bank, Goldman Sachs, JP Morgan and Royal Bank of Scotland were on board as joint bookrunners, with private equity firm KKR involved as a co-manager.

The £250 million sterling tranche carries a nominal coupon of 8.750%, but was priced at a discount to yield 9.125% or 569bp over UK gilts. The US dollar tranche was sized at $425 million and split into 144A and RegS notes. It offers a coupon of 8.375%, and was also sold at a discount to yield 8.750% or 568bp over US Treasuries.

Poorly priced

On a risk/return basis, the bond looks expensive. In the same week as Manchester United issued, industrial manufacturer Kerling, rated B3/B-, came to market with a €785 million bond. The deal had a nominal coupon of 10.625%, and priced at a discount to yield 10.75%. According to Jonathan Pitkanen, a credit analyst at Aviva Investors, had the Manchester United transaction been rated, it would have received a “single-B rating at best”.

Clearly there are pricing benefits to being a successful sports team. “Strong brands trade at a premium,” says Charles-Henri Lorthioir, managing partner at hedge fund Northlight European Fundamental Credit Fund, which invests exclusively in European high yield credit.

Although the bond markets saw spread widening across the board in late January, the immediate secondary market performance of the football club’s deal was especially poor. On January 27, the yield on the sterling tranche had widened to 9.881% or 649.2bp over gilts. In the dollar tranche, the 144A notes had pushed out to yield 8.987% or 589bp over Treasuries, although the RegS notes had tightened slightly to 8.738%, or 563.8bp over Treasuries.

According to Pitkanen, the sterling tranche’s comparatively weaker secondary performance is a reflection of UK investors’ stronger understanding of what could happen if the team’s performance on the field deteriorates. “The deal has been marketed heavily in Asia and the US, where debt issues from sports franchises are common in that market. But investors don’t realise the risks are completely different. They don’t have the possibility of being relegated from those leagues, and that’s where the pain starts.”

Once the deal was closed, £400 million of the proceeds were loaned on an interest-free basis from Manchester United Ltd to Red Football Joint Venture Ltd, a group entity, but not one of the guarantors.

Market participants predict the loan will be used to partially pay off Red Football JV’s £138 million payment-in-kind (PIK) notes issued in August 16, 2006. As with the recent bond issue, these were secured against the club’s assets and are due to mature in 2017. The interest rate on the PIK notes is currently 14.25%, which will increase to 16.25% on August 16 this year. According to an investor who attended the London roadshow for the deal, Red Football JV will look to pay off £70 million of the notes early.

Although it has come from debt rather than equity, the £400 million sum appears as a capital injection in Manchester United Ltd’s financial accounts. This will help lower its leverage ratio, which will likely have tax benefits, according to the investor.

Junior creditors

One major concern for investors is the £75 million revolving credit facility the club entered into as it was in the process of issuing the bond. Although the bonds are secured by first-priority liens on all the shares and the property and assets of the club, the providers of the credit facility have priority with respect to the proceeds of the collateral. In other words, the bonds effectively rank junior to the bank loan.

“In today’s market, with the reliance on the debt capital markets, why should the banks have seniority over investors?” says Pitkanen.

Furthermore, the credit facility does not decrease if the debt under it has to be repaid with the proceeds from asset sales. The club could sell the stadium, repay the credit facility with the proceeds, and then re-borrow under that same facility the next day.

Some market participants say investors should have insisted the size of the credit facility is reduced with the proceeds from any asset sale. There is also a feeling investors should have demanded considerably tougher covenants, in particular an assurance the club will not incur any more debt that is pari passu or senior to the current notes. Chaice says a higher fixed charge cover ratio, of perhaps 2.25:0, rather than the actual 2:0 would have been a reasonable request.

There are also worries regarding the quality of the assets against which the bond deal is secured. As the players cannot be secured, the club’s most substantial asset is the stadium, worth an estimated £240 million. However, it is unlikely the club would ever be able to sell Old Trafford to any other football team, firstly because the terms of the transaction insist that in the event of a sale, Manchester United retain their current playing rights.

Manchester’s other team, Manchester City, already has its own stadium. Other usages for the stadium are conceivable, but its prestige means the local council is likely to insist it retains its original use.

Bondholders could theoretically attempt to sell the stadium in the event of default, but in those circumstances its value would likely plummet. Consequently, the only viable option would see the stadium being leased back to the club.

According to Pitkanen, without the stadium the club’s tangible assets are worth less than £15 million. Furthermore, two of Manchester United’s other key assets, the Manchester international freight terminal and the Carrington training ground, have not been included in the collateral that the bond deal is secured against.

Performance on the pitch

It is doubtful the club will be relegated from the Premier League any time soon, but it is not beyond the realms of possibility it might miss out on qualification to the Uefa Champions League in the next seven years. Failure to qualify would hit television revenues, gate receipts and other commercial contracts. Revenues would fall, but its cost base would stay the same, which could make it extremely tough for the club to service its debt.

Although the club reported group turnover of £278.8 million for the 12-month period ending June 30, 2009, the figure was inflated by the sale of Cristiano Ronaldo to Real Madrid for a world record transfer fee of £80 million. Without the deal, the club’s £25.6 million profit would have been a heavy loss.

Manchester United have been successful in recent years, but sport is littered with seemingly unbeatable dynasties that dominate for a period, only to be replaced by a rival team. It is this unpredictability that makes a football club an unlikely high yield issuer.

“It is not the type of company profile that fits in well with the high yield market,” says Northlight’s Lorthioir. “The visibility for the club’s future is not great: what happens if Alex Ferguson leaves or rival clubs continue to invest more on new players? The competition has got a lot tougher because of the investment being made at other clubs.

“It is difficult to say with certainty that the club will be successful on the pitch, which will have consequences for its fortunes off the pitch. You could compare it to an investment bank: it might have had top performers who have done well over a long time, but then become complacent. Talent can also leave. Investment banking is a volatile business, and so is football,” adds Lorthioir.

Bond issuance in the football world has a chequered history. Between December 1999, when Newcastle United completed a £55 million securitisation backed by future ticket sales and hospitality revenues, and April 2003 nine clubs had completed securitisation deals, including Leeds United, Leicester City and Ipswich Town.

But after Leeds United defaulted on its payments to investors and Leicester City and Ipswich Town went into receivership, the asset class ground to a halt as investors realised the covenants on the deals were insufficient to protect them from financial losses.

Leeds United had invested heavily on players in the hope of competing with Manchester United. Its failure to do so hit revenues and saw it rapidly sucked into a debt spiral. Meanwhile, payments to investors by Leicester City and Ipswich Town were largely dependent on TV revenues from ITV Digital, which subsequently collapsed.

Arsenal completed a £260 million securitisation in 2006 that, so far, has successfully avoided the pitfalls of these earlier transactions. Strict covenants were applied to liquidity provisions and the deal was substantially over-collateralised.

Deal terms
Issuer: MU Finance plc
Date of issue: January 22, 2010
Size of deal: £512 million-equivalent
Maturity: February 1, 2017
Ratings: Unrated
Bookrunners: JP Morgan, Bank of America Merrill Lynch, Deutsche Bank, Goldman Sachs, RBS. Co-manager: KKR
Sterling tranche: £250 million; 8.750%; price: 98.089; offer yield: 9.125%
Dollar tranche: $416 million; 8.375%; price: 98.065; offer yield: 8.750%