Cash is King: Pandemic leaves sports clubs scrutinising their business in pursuit of cash flow
The sports industry has been on an ever-upwards trajectory in recent years, especially at the top of the sports pyramid. KPMG recently valued the top 32 European football clubs at €35.6 billion in aggregate. On the other side of the pond, Forbes values the 32 U.S. National Football League (NFL) franchises at a staggering $91.4 billion. The growth in values has predominantly come from huge increases in income from broadcasting contracts and advertising. This has also been supplemented by an expansion in commercial sponsorship. For instance, 2017 saw the National Basketball Association (NBA) introduce jersey sponsors and the English Premier League (EPL) introduce a second sponsor to players’ shirts. However, this growth has been predicated on there being sporting action. Income has largely evaporated as a result of Covid-19.
Sports clubs suddenly have no gameday income. The absence of income is a particularly acute problem in less lucrative sports leagues, where budgets already offered very little headroom to cope with the absence of budgeted income. Any proposals to resume sporting action without fans in attendance is not a remedy for these smaller sports clubs. While the top rungs of the sports pyramid now receive most of their income from broadcasting, those at the bottom are still dependent on ticket sales and concession spending during matches.
The football summer transfer window is due to be delayed to accommodate completion of the existing season. That further delays access to the most important source of income for many smaller European football clubs: player sales. This delay has already been credited with forcing MSK Zilina, one of the biggest clubs in the Superliga in Slovakia, into liquidation.
The nature of the player transfer market also risks triggering a domino effect of cash-strapped football clubs. Transfer fees are frequently paid in instalments, rather than a lump sum when the player is acquired. A new round of instalments will be due this summer. Seller clubs are dependent on the buyer clubs to make that payment on time.
“Possession is nine-tenths of the law”
Broadcasters face a similar battle to preserve cash. Schedules ordinarily dedicated to sports remain devoid of live sport. (As one of the few football leagues still active, as well as a horde of new fans the Vyšejšaja Liga in Belarus has recently gained broadcasting contracts.) Customers are suspending subscriptions. Advertisers are slashing budgets.
A concern for sports clubs is that their broadcasters will seek to reduce the amount payable under broadcasting contracts in response to any cancelled games. Top sports leagues stand to lose hundreds of millions in income if the current season is not completed. The outcome of any contractual dispute remains uncertain. But sports leagues are seeking to honour their broadcasting contracts as far as possible. The English cricket season may be curtailed to focus on just two of its domestic competitions, the T20 Blast and The Hundred, and honouring their more lucrative broadcasting contracts. The NBA may prioritise playing 70 (instead of 82) regular season games in order to satisfy the reported obligations owed to regional sports broadcasters. The EPL, the NBA, Major League Baseball and the National Hockey League have all reportedly been contemplating playing games in a quarantined sports camp based in a single city without any fans in attendance. Some sports leagues are even trying to replace traditional events with virtual esports events in order to offer broadcasters some alternative content to broadcast.
For sports clubs and leagues that have already been paid in advance under broadcasting and sponsorship contracts, they will hold onto such advance payments as a source of liquidity. Although Fox Sports has agreed to pay the Dutch Eredivisie its final instalment for this season, sports leagues generally cannot expect to receive further instalments until games return to broadcasters’ screens. The cash position of some sports clubs may only be truly tested once they don’t receive their next scheduled payment.
While the adage (and Hollywood favourite) that “possession is nine-tenths of the law” is not true as a matter of law, leverage in ongoing commercial negotiations will partly be determined by whether money is already in the hands of the sports club or its counterparty. Courts around the world are operating at a reduced capacity and cannot be expected to quickly resolve commercial disputes.
Financial support from the top
There is usually no system compelling a redistribution of wealth within a sport to keep its clubs in business. (U.S. sports leagues are the main anomaly due to their system of revenue sharing and collective bargaining.) The EPL has made greater efforts than many football leagues to distribute broadcasting income relatively evenly between its 20 clubs (although those clubs participating in UEFA competitions benefit from additional income). It also provides “parachute payments” to clubs relegated to the English Football League (EFL) Championship and “solidarity payments” to be divided up amongst the EFL clubs.
The EFL has nevertheless seen numerous clubs battling financial difficulties this season. Bolton Wanderers began this season in administration. Bury has been expelled from the EFL completely. Macclesfield Town and Southend United have repeatedly failed to pay their players on time and have faced winding-up petitions due to unpaid taxes. The sudden loss of income due to Covid-19 risks leaving a financial hole for all 72 EFL clubs, reminiscent of the collapse of ITV Digital in 2002. Without remedying this loss of income, many EFL clubs may face financial difficulties on a perennial basis. Some football clubs are relying on the generosity of their richer neighbours. The same will be true in many footballing countries.
Resisting cash flow insolvency
When any sports club faces questions regarding its financial health, the inevitable fear is that it is slipping towards insolvency. The legal test for determining whether a company is insolvent varies between legal jurisdictions. It commonly revolves around whether (i) liabilities exceed assets (the “balance sheet test”) or (ii) debts are unable to be paid as they fall due (the “cash flow test”). It is the cash flow test that will be concerning sports clubs at this time. Huge valuations do not imply huge cash reserves. One sports league has already fallen victim to the crisis. The second iteration of the XFL American football league was forced to cancel its inaugural season and has filed for bankruptcy. Sports clubs find themselves with three options to pursue: increase income, reduce costs and/or receive an injection of capital.
Increasing income will be difficult in the current circumstances. While the transfer window is closed, some football clubs could utilise factoring of their transfer fee receivables to raise capital from player sales now. However the presence of any factoring arrangement may conversely complicate any attempt by debtor clubs to negotiate any delay to their next payment instalment with the seller club.
Most costs from running a sports club are relatively fixed. The largest items are likely to be staff salaries (and amounts owed to players’ agents), rent on any leased property, debt servicing and taxes. Governments have allowed deferral of tax payments. Banks and landlords may be prepared to allow added breathing room, particularly in response to government directives. It is, therefore, unsurprising that the immediate focus is on player salaries in order to conserve cash.
Cutting playing staff costs
U.S. sports leagues and their collective bargaining agreements typically cap player income at around 50% of league income. Other sports leagues, however, typically allow each club to individually determine what it is prepared to pay in playing staff costs. UEFA raises a red flag where playing staff costs exceed 70% of a football club’s income. According to Deloitte, though the average figure for clubs in the EPL stands at 59%, it is 106% for clubs in the EFL Championship.
It is prudent for any business to attempt to agree payment holidays and deferments with its largest group of creditors. The reaction has been mixed. Some sports clubs have released players that were not willing to accept pay cuts or deferments. The handling of expiring player contracts also adds further complication to negotiations. Yet numerous sports clubs and their playing staff have agreed to compromise. The EFL agreed with its players’ representatives a “recommendation” for a 25% pay reduction in League One and League Two. Ligue 1 in France agreed with the players’ union that there will be a league-wide pay reduction of up to 50%, depending on each player’s salary. But, as each sports club is in a different financial situation with different playing staff costs, a blanket policy across a sports league is not always achievable or appropriate. For instance, the EPL failed to agree a 30% pay reduction with its players.
In each case players will expect transparency and that their employer demonstrates the financial basis of any request. Any prudent creditor would expect the same before committing to cancel or defer any debt or future payment that it is owed.
A number of sports clubs are owned by high net worth individuals, investment funds and even state-owned entities. UEFA has suggested a willingness to relax Financial Fair Play rules for European football club owners to contribute funds to counter the side-effects of Covid-19. In some cases, at smaller sports clubs or those sports clubs owned by supporters’ groups or club members, owners may lack the financial means to provide immediate cash liquidity. But there is generally the potential for owners to keep their sports clubs afloat. Players and other creditors may ask why they should make financial sacrifices if owners fail to share the pain.
Sports clubs will typically have access to some debt financing. It may be a term loan or bond issuance for longer-term financing. It may be a revolving credit facility or overdraft facility for short-term liquidity. These options could potentially also be tapped and even further extended. The NBA, for example, extended its line of credit in the immediate aftermath of its season being suspended – and those funds can, in turn, be on-lent to its franchises. However, again this may be a luxury that smaller sports clubs and leagues lack the financial standing and collateral to exploit.
Goodwill has a monetary value
National governments are offering financial support to businesses impacted by Covid-19. This includes covering staff costs, offering business loans or loan guarantees and allowing deferral of tax payments. Sports clubs will be eligible for such schemes on the same basis as other businesses. English football clubs have already used the Job Retention Scheme to furlough players and non-playing staff. However, some EPL clubs have already received a public backlash for seeking taxpayers’ money when they should have the means to fund themselves.
Sports clubs also cannot handle their creditors and debtors on the basis of business as usual. Non-playing staff (especially gameday staff) will offer the least onerous contracts to terminate when sports clubs attempt to cut staffing costs. Payment for next season’s season tickets may be due soon. Failing to pay invoices in a timely manner or refusing forbearance on debts owed could aid a sports club’s cashflow. All now carry a greater social stigma, particularly when they impact on the traditional fan base and local businesses. Any of these financial gains are only likely to be consequential at the smaller sports clubs. They may be counterproductive for larger sports clubs once they account for the wider repercussions from their decision.
Sports clubs are temporarily restructuring their business to maintain enough cash to remain afloat. It is cash at hand that is determining their financial health, not their contracted income or paper valuation. There will be many commercial and legal issues to consider. That does not, however, mean that the wider societal implications of business decisions can be overlooked.
Sports clubs will be interacting with employees, commercial counterparties, sports bodies, governmental authorities and other stakeholders. There will be long-term implications for each relationship from any short-term decisions that are made now. Engaging proactively with counterparties to resolve financial difficulties can be of better strategic value than unilaterally derogating from obligations. Sports clubs hold a special place in their local community and the national (and even international) psyche of sports fans. Beyond questions of moral obligation, there is an intrinsic (and monetary) value to their brand in being seen to do the right thing.