WARNING: This is long and only intended for those really interested in LFC.
The following is an attempt to summarise the background to the current takeover speculation. There’s a lot missed out, particularly the £40m+ a year in interest that’s being accumulated: whilst this is of critical importance, it slightly clouds the issue.
If anyone wants to skip most of what follows, points 8 and 9 are the important ones…
1. Debt for equity
When the club was originally sold to Tom Hicks and George Gillett, the price paid was £218.9m, which included the £44.8m of debt the club had at the time – that’s like having a £20,000 mortgage on a £100,000 house.
The club was financially independent and the many years of good stewardship, particularly under Sir John Smith and Peter Robinson, had seen the books balanced and the long-term financial security of the club kept as a priority.
Whilst the new owners promised no debt on the club, that was only technically correct: the new ownership structure was complex and involved significant debt, albeit this was put against one of the holding companies rather than the club itself.
The new ownership structure comprised a Delaware-registered company co-owned by Gillett and Hicks, the four subsidiaries:
Kop Investment LLC
Kop Football (Cayman) – registered in the Cayman Isands, presumably for tax reasons
Kop Football (Holdings) Ltd – the UK holding company (‘Kop Holdings’)
Kop Football Ltd – a UK intermediary company, whose purpose is a little unclear
The Liverpool Football Club and Athletic Grounds Ltd – the club itself
The purchase of the club was initially funded by a loan from RBS and Wachovia, which took the form of an initial loan of £185m to Kop Holdings.
Although there was no significant debt taken on by the club itself, the financial structure via the holding company only briefly disguised the fact that the purchase of the club had been funded by debt and not by equity.
2. How much does the club owe?
Recent press speculation suggests that the loan from RBS/Wachovia was restructured sometime in the spring of 2010 and that the debt is now held solely by RBS, amounting to £237m (albeit this may be growing due to rolled-up interest and potential penalty clauses.)
The structure of the debt is complicated, to say the least: the £233m bank borrowing was held by the club and Kop Football Ltd, whilst Kop Holdings owed £144m to Kop (Cayman).
The loan from Kop (Cayman) is interesting, in that it appears to be the ‘equity’ put in by Hicks and Gillett in order to get RBS to agree to the refinancing. Speculation as to the source of these funds is rife, but suffice to say that (i) it doesn’t seem likely that it’s pure ‘equity'; and (ii) it attracts a 10% annual interest charge, so it’s hardly equity: it’s just another loan.
So, that’s £377m of debt, even if accruals, trade creditors, tax owed and deferred income are overlooked.
3. Where did the debt come from?
Over three years, bank borrowing has risen from £185m to £377m, caused by two main factors.
Firstly, the club has been spending money, with the new stadium design costs (about £45m) contributing a large part of this.
Secondly, it appears that the interest costs of the loans have not necessarily been covered by the club’s operating profit and that the interest has merely been added to the value of the loan. This is, in blunt terms, a spiral of unsustainable debt.
4. How bad is it?
The blunt assessment of the club’s auditors is that there is uncertainty as to whether the club can continue as a going concern.
This is underlined by the worth of the group, which is insolvent to the tune of £128m, up from £75m the year before.
More than annoy other statistic, this figure is worth underlining: the value of the club, less the debt secured against it, is minus £128m. It is insolvent, bankrupt, broke, whatever else you want to call it.
To make matters worse, some of the assets of the group are probably worth less than they might appear to be.
Firstly, design costs and professional fees for the new stadium are included as assets of the club, totalling £45m. Whilst this is not unusual for a project that is in progress, were the plans not to go ahead in their current form, there is a massive loss to be taken when the costs are written off.
Secondly, there are two amount of ‘goodwill’ capitalised in the accounts: these represent the difference paid for an asset and its book value, which are then written down over a prescribed period.
On the books of the club is £13m of goodwill relating to the purchase of 50% of the LTC TV joint venture, from when the club bought out Granada.
Kop Holding has £46m of goodwill, relating to the original purchase of the club.
The significance of the stadium costs and the ‘goodwill’ is that they’re not actually asset that could be relied upon to be sold if an urgent sale were required: it’s thus possible to consider that there’s an additional £104m that could be added to the funding shortfall, thus bringing the level of insolvency to £232m.
It might also be worth mentioning ‘Intellectual Property Rights’ at this juncture: these account for another £28m of assets, although in reality these probably do have a real-world worth.
Remember, though, that figure of £232m is as at 31st July 2009: it’s got worse since then.
5. What’s the club actually worth?
According to the accounts, the club has a total of £150m of assets:
Players (net book value): £108m
Tangible assets, cash & debtors: £14m
Land & buildings: £28m
In addition to this are the new stadium costs (£45m) and the LFC TV goodwill (£13m)
However, in my opinion, the players are undervalued; and taking into account some of the stadium costs and in particular ‘brand value’, Liverpool Football Club would be worth perhaps £300m – £350m to a buyer, assuming it carried no debt.
That figure is – of course – speculative, but if you were to consider that Manchester United is reputed to be ‘worth’ around £700m including a 75,000 capacity stadium; and that a new 75,000 capacity stadium for Liverpool would cost approximately £350m, then the figures lead towards a value in the region of £350m maximum.
RBS is the key to Liverpool’s future: according to recent newspaper reports, the debt with RBS currently stands at somewhere in the region of £280m, taking into account various interest charges and the fees associated with the spring refinancing.
The current loan is due for review in October, but RBS have assured the Premier League that they will continue to support the club until the end of the 2010/11 season.
It now seems almost certain that the most recent refinancing was only approved by RBS as a temporary measure pending sale of the club.
The arrival of Martin Broughton as chairman, to oversee the sale of the club coincided with the resignation of Foster Gillett and Casey Shilts from the board of Kop Holdings – this gives RBS a 3-2 majority on the board, as long as Ian Ayre and Christian Purslow vote with Broughton’s vote.
The reasoning behind this is pretty simple: RBS were not willing to allow Hicks and Gillett to retain a veto over the sale of the club and this would have been a condition of the refinancing.
7. Breaking point
Aside from the intricacies of the group structure and the fine detail of the accounts, the current situation is pretty simple.
Kop Holdings, considered as a group, owes £280m to RBS and £144m+ to its parent company, ie Hicks and Gillett.
It owns a single asset, Liverpool Football Club, which is probably worth between £300m and £350m.
The debt to RBS continues to grow, but – crucially – it is still less than the value of the club at the moment.
RBS have gained the ability to force the sale of the club, via its control of the boardroom: they have to do this while the debt they are owed is lower than the value of the club, otherwise they will make a loss.
The £144m owed to Kop Cayman is not a particular consideration to them: if the proceeds of the sale can cover that, all the better, but when it comes to the crunch, RBS’s only responsibility is to its shareholders – and if that means selling the club for £290m when the debt is £290m; and Hicks and Gillett making a loss of £144m+, then so be it.
This, of course, explains the rumoured legal threats by Gillett and Hicks to allow them to attempt to refinance with someone other than RBS, with it appearing that RBS will only accept outright sale.
Similar, it would explain the apparent attempts by the owners to obfuscate the sales process, if anything just to buy time until richer buyers come along and enable them to find an exit strategy that includes a profit.
8. Administration looms?
Newspaper reports suggest that the current loan is due to be refinanced in October, with RBS having every intention of selling before then.
There is also some suggestion that the bank could then take effective control of the club at that point, by calling in the loan: if the owners were not able to find the money then the bank would become de facto owners, free to dispose of the club to cover the debt.
This strategy would, almost certainly, be subject to legal challenge by the owners, who would stand to lose in excess of £144m, that being the sum owed to Kop Cayman. However, it is likely to be the case that RBS has written provisions for such an eventuality into the current loan agreement, so any such challenge may be destined to failure.
The question then would be whether or not the bank assuming control of Kop Holdings in October would be considered ‘administration’ by the Premier League: that’s not an easy one to call at this stage, but it has to be a concern.
Were the club to be put into administration in October, then the 9 point deduction would immediately harm the potential sale value of the club, thus if RBS can avoid administration, they will do so. It is, certain that any October refinancing would be accompanied by even more onerous conditions imposed, removing yet more control from the owners.
If, by some combination of events, the club remained unsold at the end of this season, the value of the debt to RBS would almost certainly exceed the value of the club, even if there had been player sales in the January transfer window in an effort to bring down the debt. Under those circumstances, administration must be considered a very strong prospect.
The likelihood, however, must be that the club is sold at some point between now and October: that is what RBS are pushing for and that is the only means by which the spectre of administration will be lifted.
9. The point of no return
The words of Philip Long of PKF accountants, quoted in the Telegraph, are probably the most salient on the subject:
“Liverpool’s is not a long-term business model. There simply is not a happy ending to leveraged buy-outs. The burden of the interest outweighs any profits the club make, and that becomes unmanageable.
“The two Americans hanging on and seeing their debt refinanced by RBS, continuing to pay interest, is a far worse scenario than the bank taking over the running of the club. The debt burden will just increase to a point where the interest is not being serviced any more. The ultimate end game, if Hicks and Gillett cling on, is that Liverpool goes bust.”
That point of no return, where the profits no longer cover the interest, has probably already been passed. The only question now is whether or not RBS can sell the club before it is forced into administration.