Making money from football shares?

The UEFA Champions’ League is now in the knock-out rounds and I was remembering a presentation by a value manager once where he exposed why he preferred buying shares in leading English football clubs rather than BSkyB the broadcaster. To him, Sky was a price taker, forced to pay up while Man Utd would ride on ever higher TV rights. 

I just noticed that BSkyB is back at its 2011 high, when it received a bid offer from Rupert Murdoch.

Looking historically, since the float, BSY has returned 7% pa on the capital front and probably another 3% on the dividend side, which adds to a nice 10% pa return. This is nearly 4%pa better than the FTSE 100.

However, BSY had to pay up a significant amount for the last round of TV rights and it remains to be seen whether it can continue to increase pricing to keep margins up. 

Sadly, there is only one vehicle to play the English Premier league: Manchester United FC, listed in the US. The other potential clubs that I discard are Arsenal (no float) and Celtic Glasgow (unless they move to the Premier league).

Manchester United trades on 30x 2014e earnings after taking into account the new TV bumper deal starting next year. On 2015e earnings, it is still on 22x.

EV/Sales multiples are also sky high, on 4.9x 2014e despite operating margins only at the 20% level.

There is an expectation that turnover can continue to increase at a 10% compounded annual clip – it has historically but the starting base now is much higher.

It is as if the shares already discounted Man Utd going to play in a closed European Super League in the near future.

Therefore, we need to find another candidate in a strong league, where expectations are not so high.

This league needs a global reach, good entertainment, sound financials, a strong support base to deliver solid commercial revenues.

The German Bundesliga fits the bill: the games are played in the afternoon, enabling Asian viewers to follow them, the league has the highest goal per game ratio, average attendance at 42,000 per game is the highest in Europe and clubs are obliged to be profitable.

The German league is catching up in terms of revenues with England, Spain and Italy.

German clubs usually have strong commercial income but relatively low match-day income and TV revenues compared to their peers, especially in the English Premier League (EPL).

Low TV Revenues stem from the bankruptcy of Leo Kirch in the early 2000’s. Then, TV rights were set in 2002 at a ridiculously low of €180m pa (the EPL just signed for £1bn pa from next year just for domestic viewers!). They rose to €625m pa in the last cycle, starting this season. This is still half the EPL level and the English league still gets another £2bn for 3 seasons on top thanks to foreign rights.

However, one can imagine that TV rights can only go up for the German league, especially as its clubs go further in European leagues, catching more eyes.

The listed candidate is then easy to find: Borussia Dortmund (BVB GY).

After terrible years in indebtedness (trying to match Bayern Munich sporting clout), the new management is now a lot more astute: they arrived in 2005-6 when the leverage was at its highest and league position poor and turnaround the fortunes.

The club is now firmly attached at the top of the league, drawing Champions league TV income, has 80,000 spectators every home games. It has some leftover debt from the past – around €60m, ensuring management will continue to be prudent but net debt is now only 1x Ebitda, which is manageable despite the lack of fixed assets. 

Revenue split is the following for 2012 (source Deloitte): matchday 17%, broadcasting 32% and commercial 51%.

With the better sporting performance and crowd support, we could expect the matchday and commercial income progress at least at a 6-7% annual pace. Broadcasting will step up every 4 years as TV rights get renegotiated higher.

In 4 years, we could expect having matchday income at €45m (vs €32m), broadcasting at €100m (vs €65m) and commercial at €150m (vs €92m), giving nearly €300m of revenues.

With a 15% net margin as delivered today and a 10x forward PE in 2016e, this implies a market cap of €450m and can deliver 30% annual price appreciation to the shares.

Today, the shares are trading on less than 8x PE with expectations that sales hardly progress in the near future.The shares have gone up recently based mostly on earnings revisions as the market still think the good sporting position will reverse.

The downside is the Borussia not qualifying for Europe anymore, losing some TV and commercial revenues. There, sales would drop towards €170m, with a 10% net margin and a 8x PE, this implies a 31% downside.

The upside is 125%, giving a 4x risk/reward ratio, which is appealing. 

But I am not a football expert.