Monday, March 22, 2010

Hull To Pay

Hull City’s hopes of escaping relegation from the Premier League were dealt a savage blow on Saturday when they conceded two late goals to fellow strugglers Portsmouth. Defeat on the south coast was surely not in chairman Adam Pearson’s script when he installed Iain Dowie in the bizarre new role of Football Management Consultant as replacement for colourful manager Phil Brown, after the karaoke king had been placed on gardening leave following another run of poor results. Leaving aside whether a man with as undistinguished a record as Dowie is the best man to guide Hull to safety, the change was obviously a desperate gamble to avoid the disastrous financial implications of dropping down to the Championship, coming just a few weeks after Pearson had said, “We genuinely want Phil to succeed and for him to be here for many years”.

Fans first became aware of Hull’s financial problems when the 2008 accounts were issued late – several months late. This just happens to be a criminal offence, whatever former chairman Paul Duffen might say, so the financial community does not consider this a trivial matter. Of even more concern was the warning from the club’s accountants Deloitte that the difficulties the club might face in raising finance “represent a material uncertainty that may cast significant doubt over the company's ability to continue as a going concern”. Strong words indeed. They further cautioned that Hull had to repay all their £22m bank loans by July this year. In order to operate within their finance facilities, the club would need to generate a surplus of £23m if they were relegated or £16m if they somehow managed to retain their Premier League status.

"The shy, retiring Paul Duffen"

Although that did not seem an enormous amount compared to debts at the likes of Manchester United and Liverpool, at the risk of stating the obvious, Hull do not have the revenue generating potential of those clubs. In fact, the 2008 accounts reported a loss of £9.8m, though fans were quick to point out that this period covered their last season in the Championship. Duffen openly boasted that the loss was a result of the decision to bump up the players’ salaries by £6m in order to secure promotion to the lucrative Premier League, which was memorably achieved via Dean Windass’ spectacular volley in the Wembley play-off final. In many ways, this approach was completely understandable, as it allowed Hull to compete with those clubs coming down from the Premier League, who could afford to pay much higher wages, boosted by parachute payments of £10m. Speculate to accumulate, right? However, this did mean that Hull’s wages doubled to £14m before they had played one game in the top division with an unsustainable wages/income ratio of 124%, though they would certainly have anticipated improving this with the much higher revenue available in the Premiership.

The board’s confidence that the 2009 accounts would be far more positive after their first historic season in the Premier League appeared justified when they were published last week. On the face of it, the figures look much better. Yes, salaries have jumped by another £19.6m to £33.6m, but this was more than covered by the significant £39.8m increase in turnover from £11.3m to £51.1m. Most of the increase, £33.5m, is attributable to the higher revenue distributions from the Premier League compared to the Football League. As forecast by the directors, this resulted in a small pre-tax profit of £2.0m. So, the bet has paid off? Not quite. The auditors repeated last year’s bleak warning, though the amount of money that Hull would need to find if relegated was slightly lower at £21m (£16m if Harry Houdini makes an appearance at the KC Stadium). Yet again, the auditors wrote of “material uncertainties” that “may cast significant doubt about the company’s ability to continue as a going concern” in their so-called “Emphasis of Matter” statement.

"Sing when you're losing"

How can this be? Well, as the old saying has it, turnover is vanity, profit is sanity, but cash is king. Even though Hull made a small profit, they also reported a net cash outflow of £4.6m, mainly due to repayment of bank loans £6.9m, interest on those loans £1.6m and buying players (net) £5.5m. The balance sheet may not be tremendously interesting, but it is vitally important to any company, especially the debt at a time when capital is no longer freely available. The accounts show that Hull ended the financial period to 31 July 2009 with bank loans of £15.1m. Although this was lower than the £22.0m in the 2008 accounts, Hull’s net debt was never higher than £1m in any of the previous six years, placing this amount into context. In the same way that Portsmouth funded their FA Cup success with debt, Hull followed the same route to finance their promotion campaign.

Returning chairman Adam Pearson has evidently appreciated that this is an urgent issue and has reduced the debt to £4.6m today (one of the lowest in the Premier League,) having made payments of £7m in August and £2m in both January and February. Impressive stuff, but the harsh reality is that Hull still need to repay the outstanding debt in full to Investec Bank in July, which is probably why the latest accounts mention that “The club is currently in advanced discussions with finance providers for the acceleration of known Premier League distributions for amounts of £7m”. Importantly, Hull also owe £4.5m in tax. You only have to look at events at Portsmouth and Southend United to see how eager Her Majesty’s Revenue and Customs are to get their money these days, even if this results in a club going into administration or being wound-up. On top of that, the club has £14.6m of trade creditors (up from £2.8m the year before), which includes £12.8m relating to player transfers. These are presumably installment payments, but there is no information on when they are due. Sooner rather than later would be my guess, given the red flag raised by Deloitte.

"No worries"

Pearson has characterised the excesses of the Duffen era as “too much champagne and not enough ale”. Football finance expert Stephen Morrow, Head of Sports Studies at the University of Stirling, agreed, “There comes a point when a club has to stop following the dream and ensure it runs on a sustainable basis”. Fans would have been reassured by Pearson’s calm, reasonable words, “The position of the club is manageable going forward, but if it had been left much longer, there was a danger of it becoming more serious. I shall be running the club from top to bottom to get it back on track, working strictly within the financial budgets that have been set”.

The most obvious problem is the wage bill. As a result of what appears to be a completely dysfunctional recruitment policy, Hull have somehow ended up with one of the highest payrolls in the Premier League, despite their lowly league position. To his credit, Pearson has recognised this anomaly, “The problem is to reduce the wage bill, which is £38m, from the sheer weight of players on the club’s books. My job is to reduce that”. In a horrible echo of other clubs with economic difficulties, Duffen had demonstrated his ambition by bragging of spending £19m on new players in 2009, but according to Pearson this resulted in “£12m sat in the stands every week”. He also noted that £5.3m has been committed in agents’ fees and £2m is payable in bonuses. Although the club have not made any massively expensive signings (the injury-plagued Jimmy Bullard is the highest at £5m), some of the salaries have raised a few eyebrows: the non-scoring forward Daniel Cousin was on £25k a week; the limited Bernard Mendy £22k; and the club captain Ian Ashbee was given a new £20k contract while out injured for the whole season. While he is about it, Pearson may also want to look at Directors Pay, which increased by an amazing 700% from £250k to £2.0m in 2009. Including pension contributions, the highest paid director pocketed a cool £1m …

"Hey, big spender"

Paul Duffen resigned from his position as Hull chairman last October, stating that he should “take ultimate responsibility for the disappointments of 2009”. When he referred to awful results, most assumed that he meant on the pitch and not the financials, even though his exit came just one day after the publication of the alarming 2008 accounts. This was obviously just a coincidence, as he had maintained that “there are no problems here, the club is properly financed”, when invited to comment on the reasons for the delay in issuing the accounts. Sounding horribly like Peter Ridsdale, he whined, “There has been an awful lot of misinformation and misinterpretation of what happened on my watch at Hull”. As anyone who has been unfortunate enough to observe Duffen on Sky Sports will appreciate, this is a man with a gigantic ego who is just as happy to bask in the limelight as his former manager, so it was all the more strange when he claimed that the Guardian’s article on the 2008 accounts “contained a number of inaccuracies” - without taking the opportunity to specify what these were supposed to be.

To Duffen’s credit, he did appreciate Hull’s enormous latent potential, describing the club somewhat clumsily as “a perfect box-tick”. It’s a one-club city with a wide catchment area, no competitors nearby and a brand new stadium paid for by the local council that attracts nearly 25,000 crowds. Whether the club is a good investment is important, as Pearson is reported to be seeking £25m of new money, “'It is part of my remit to get extra money into the club. Every Premier League club is in a position where it is looking for external investment. It is a big responsibility financially for myself and owner Russell Bartlett to manage alone and we are looking to ease that burden and provide a secure foundation for the club”. This is why it is imperative to stay in the top division, as every club receives around £40m in TV money alone, while Richard Scudamore has just secured a bumper new £1.2 bln overseas TV agreement worth an additional £20m per season for the next three years. Hence, Pearson’s fear of relegation, “People are very canny. They won’t invest if there’s an element of risk”. Hardly surprising, when you look at the monetary difference with Hull’s time in the lower leagues: their revenue of £51m in their first Premiership season is more than the revenue they earned in the previous six years combined (£50m).

"See you on Soccer Saturday"

Unfortunately, any potential investors will have noted that Hull have very few assets. Unlike most other football clubs, they do not own their stadium, so there are only £103k of tangible fixed assets in the books (probably lower now on the assumption that Phil Brown took his sun bed with him). The stadium was built with £43.5m of public money, so is owned by the council. This is a double-edged sword: although he club did not have to incur large debts to develop the ground, they have no major asset to mortgage and they have to pay rent to the council. The other (intangible) assets are the players, who are carried in the accounts at a value of £19.2m, representing the amortised cost of players’ registration fees. The directors have estimated the current value of the squad to be £35m, but that seems very high to me, as there are few players in this struggling team that would command large fees. Although Pearson has said that “there’s no need for a fire sale”, the fact is that Hull are unlikely to achieve top dollar for any players if they need the money. This is what happened at Leeds when they were forced to make distress sales. It is not clear whether the players’ contracts contain clauses reducing their salaries in the event of relegation. Duffen seemed to indicate that this was the case, but he added, “The players’ contracts stipulate they can leave for free” if this came to pass. On the one hand, this would help balance the books; on the other hand, there would be no monies generated from the transfer.

In fact, there are still several questions about Hull City’s finances:

1. If the finances are not so bad, why is the club so keen on getting money in early?

(a) Having valued star defender Michael Turner at £12m and apparently rejected a £7m bid from Liverpool, Hull accepted a £4m fee from Sunderland. It seemed strange to cash in on their best defender, especially as this happened just two weeks after the club bid £12m for Alvaro Negredo. This was probably why Turner’s former clubs, Brentford and Charlton have asked the League to investigate the sale, as they only received £1.2m sell-on fees.

"Any tips, Peter?"

(b) Having decided to give Phil Brown the heave-ho, it was a bit surprising that they placed him on gardening leave instead of severing all ties. Some believe that this is because the club is in no position to pay the £1.5m settlement at present.

(c) The club raised £4m by selling 14,000 season tickets for the next two seasons to the ticket agency Ticketus, but at a price lower than that currently charged.

(d) Hull are borrowing against future TV money (again, shades of Leeds United here) with 2009 accounts revealing that the board has “secured funding with Investec Bank to accelerate circa 45% of known Premier League receivables (around £15m) in order to provide working capital and assist funding player trading activities”. OK, funding once-off transfers may be understandable, but surely not to cover ongoing working capital? That’s got to be a concern.

2. Why are the accountants so pessimistic?

Some have accused Deloitte of being unnecessarily cautious in order to cover their back. This suggestion was made by Duffen amongst others, “Auditing standards have changed and we are in negotiations with our auditors over a way round it. They have become much more stringent about signing-off accounts since the global economic crisis hit”. Accountants are not renowned for their sunny nature, but the reality is that they are legally obliged to review a period of at least 12 months from the sign-off date. This is based on forecasts prepared by the directors themselves, which would obviously include items such as TV money and parachute payments, which less well-informed supporters have claimed could be added to cover the shortfall. The requirement to fully repay the bank loan is clearly uppermost in the auditors’ minds and if the club had more robust plans in place, then the report would not have been so scathing.

"KC and the Sunshine Band"

3. Never mind the £2m profit, what does the balance sheet tell us?

(a) We have already seen that Hull’s cash flow in 2009 was negative to the tune of £4.6m, even though they made a profit. Cash is vital for the day-to-day running of the club and cash flow problems were the first signs of trouble at Portsmouth, made visible when players’ wages were paid late. Critically, a lack of cash can also lead to the taxman not being paid, which can end up with him having his day in court. In 2008, Hull reported a positive cash flow of £5.7m, but this was only because they took out nearly £22m of new loans. It is these figures that make the requirement to find an additional £21m (or £16m if they are not relegated) so challenging.

(b) The club has net liabilities of £11.8m, which means that the assets do not cover their liabilities. In other words, if the club sold all its assets, they would not have enough money to pay off all the people to whom they owe money. That is serious in any one’s books. Hull’s strategy was to stay a few years in the Premier League, so that the sizeable TV revenue would one day resolve this, but relegation would throw a rather large spanner into the works.

(c) The bank loan is largely secured against future Premier League money, so it is likely that a covenant will be broken if the team is relegated, meaning that the loan would be payable on demand from the bank, though it is questionable whether Investec would actually pull the plug. Having said that, Southampton were forced into administration when Barclays called in their overdraft. The loan is also covered by a personal guarantee provided by the owner Russell Bartlett, but there have been concerns expressed about how well his business is doing, as his property company is unlikely to be immune from the recession.

"Duffen ready"

4. Has there been any financial skullduggery?

On his return to Hull, Adam Pearson felt compelled to immediately call in the accountants to scrutinise the books, especially after Paul Duffen claimed he was owed money. Following this investigation, the company issued legal proceedings in the High Court, seeking £500k damages against the former chairman, “to protect the commercial best interests of the football club against the actions undertaken by Paul Duffen while in office at Hull City”. They specifically alleged that Duffen had used the club’s money for his own personal expenditure; that he had accepted inducements from agents for directing business their way; and that he was frequently absent from the stadium, which was his designated place of work. The court took the allegations sufficiently seriously to freeze some of Duffen’s assets, but the case was settled out of court last month. No details of the settlement have emerged, though the club’s lawyer explained that the club “wanted to ensure their focus from here on in is on matters on the pitch and not off it, so they are happy to resolve this issue”.

5. Why is the ownership structure so incredibly complicated?

Given that Hull City is a very straightforward business, the number of inter-linked companies is ridiculous. We have (deep breath) the company regarded as the football club, The Hull City Association Football Club (Tigers) Limited, which is owned by Tiger Holdings Limited with the ultimate parent being Isis Nominees Limited, a company registered offshore in Jersey. Russell Bartlett is the controlling party by virtue of his beneficial ownership of Tiger Holdings Limited. In addition, Superstadium Management Company Limited is regarded as a related party because of common control. This company runs Hull City’s KC Stadium and is owned by Superstadium Holdings Limited. It’s a Hull of a mess.

"This is how the company structure works"

If that (understandably) confuses you, wait until you look at the inter-company loans. Bartlett loaned £1.6m to Superstadium Holdings (£1m directly and £600k via yet another company, Bartlett’s R3 Investment Group), who then loaned £2m to Tiger Holdings, which subsequently loaned £2m back to R3. It looked like Bartlett had effectively been loaned £400k interest-free with no repayment date, though Duffen denied this, “At no time has any money ever gone out of this club, as some people have suggested, to any of Russell Bartlett’s property companies”. R3 had invested £4m in Tiger Holdings through which Bartlett bought the club, but there are suggestions that Hull City may have financed its own takeover, as Hull loaned Tiger £3.2m (again at no interest and no specified repayment date). The 2009 accounts also suggest that Superstadium Management Company owes the club £1.7m. You have to laugh when Duffen said, “At no stage has there been any obscurity about the financial results whatsoever”. It may all be completely kosher, but it still leaves you with an uneasy feeling.

6. Why does the owner not put in more money?

To be fair, Russell Bartlett has loaned a further £4m since the 2009 accounts, while Pearson has said, “He is a good owner who has put his own money into the club and he continues to fund it privately”. Nevertheless, if Hull is such a good bet and/or Bartlett is such a wonderful owner, you have to wonder why Bartlett does not provide the additional investment, instead of going cap in hand to the bank, especially as the money required to safeguard Hull City’s future is relatively small.

"Facing up to the facts"

In spite of these questions, Adam Person has emphatically stated that the club is not facing collapse, though he has acknowledged that they are struggling to meet day-to-day commitments, ”Every problem at this club is solvable and the supporters should rest assured the club is in no danger of going out of business or going into administration”. This should provide some comfort, as Pearson has a good track record. He bought Hull City out of administration in 2001 and presided over the club’s rebuilding, before selling the club to Bartlett in 2007, leaving it debt-free with £1m in the bank. He moved on to become executive chairman at Derby County, where he secured new investment, reduced the debt, slashed the squad size and cut the wage bill to put Derby on a sound financial footing.

So, it looks like Hull City have the right man for the job, at least off the pitch, though there are still many challenges to face – and indeed questions to answer. Even if the club does not go bust, it is clear that the manager will have very limited resources to rebuild the squad. Either way, Hull City feels like an accident waiting to happen. Who said that 2010 was the Year of the Tiger?

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