Wednesday, 20 March 2013

GFH Annual Report - Anything new?

GFH released their financial report yesterday so I thought it would be useful to comment briefly following my previous blog. There were a couple of interesting things which I noticed, one of which contradicts my earlier post.

My first blog commented on the $10.4m gain on acquisition of assets held for sale. This amount at the time seemed to correlate to the £4m of preferred equity (essentially a form of debt) and £2m loan against the shares in LUFC and therefore I assumed that it was GFH accounting for this initial investment by adjusting the purchase price. Having seen the notes to the accounts now (Note 9 deals with the purchase of LUFC Holdings) it appears that there has been a fair value adjustment to the value of LUFC Holdings after purchase rather than a booking of the total acquisition price. It would appear that the £6m assumed to have been invested in Leeds in the build-up to the takeover is included in the c. $35m purchase price (£23m on today's exchange rate) which I get to by netting off the $88m against the $42m of liabilities and taking off the $10m valuation gain. 

There are 2 interesting aspects to this, starting with the revaluation, it is generally very difficult to recognise a valuation gain, football clubs are not regularly traded, and a football club which doesn't own it's own stadium or training ground and has very few tangible assets is harder than most. Auditors would generally require quite a high burden of proof (however it does depend on the auditors and the financial reporting standards applied) in order to recognise a valuation gain. To my mind that would have to be either evidence of another higher counter-offer when GFH were bidding for Leeds (unlikely they would have been able to see that) or an offer was made for LUFC Holdings from a third-party in the period from acquiring Leeds (beginning December) and the year end. From my understanding, and having chatted to accountant friends, the burden of proof is generally quite high and the auditor would have to get comfort that any market offer was deliverable and credible before agreeing to a revaluation. This would indicate that it was a v firm bid, possibly with proof of funds provided.

The second aspect (which I have only considered after looking at the accounts again) is that the liabilities for LUFC Holdings look high at $42m given we are largely "debt-free". Assuming that the preferred equity and other loan (£6m) plus the loan against season ticket income (£5m) is still on the balance sheet that would get to £11m vs £28m of liabilities. There are potentially two possibilities for this, either it is possibly a recognition of a second payment due to Ken Bates upon a sale/promotion (any future payment would have to be booked as a liability) or the transaction was partly financed through some form of inter-company debt (preferred equity potentially). 

Given our recent history, people see the word "debt" and panic, but there is a big distinction between third-party debt being used (and given the poor shape of Leeds' cashflow, I cannot think that a bank would look at funding any buyout) and inter-company debt which is generally used as a tax-efficient way of purchasing an asset (basically inter company debt interest is tax deductible for UK tax purposes so it reduces the tax paid). To all intents and purposes it acts the same as equity, is generally unsecured, doesn't require interest to be paid current and just reduces tax leakage. This is however all speculation and without seeing the Leeds accounts it is impossible to know how the deal was structured or what comprises the liabilities.

The next item I found of interest was the comments regarding a sale of LUFC Holdings with it being clear that there is an "active plan by the group to sell its stake". This correlates with my earlier blog but the comment doesn't explicitly state that it is a partial sale, instead all comments refer to a sale of the whole. To my mind, that would suggest a full sale is at least being considered (which if GFH have made a 33% return on their investment (which, assuming a 6 month hold period is around 60% internal rate of return (skewed due to the short hold period) or an equity multiple of 1.3x) if the revaluation is correct sounds like a very healthy profit for a deal with no leverage given most funds these days target around 15% IRR). Time will tell but it would seem that we are likely to have new investors this year at the very least.

Finally, looking at the sale of treasury shares in more detail (Note 25: Related Party Transactions) we can see that $2.9m was sold to key management personnel. Given my belief that the treasury share sale was used to fund the purchase of LUFC Holdings, it would suggest that management have also taken a stake in the deal which is relatively common for most private equity funds. 

As ever, comments welcome, especially from trained accountants! The analysis above is my own personal interpretation of the accounts and given the difficulty in seeing through into LUFC Holdings, I will caveat that it may not be 100% accurate but hopefully sheds some light onto quite a complex deal.

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