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.

GFH and Leeds United

Following on from the release of the 2012 annual accounts of Gulf Finance House, I thought it would be useful to try and dissect what this tells us about their takeover of Leeds United and the sustainability of that investment going forward. All of the documents referred to below can be found on the GFH website under Investor Relations. To clarify, I'm not an accountant by background therefore the analysis below is more from a corporate finance background. I welcome any input or improvements on the below!

Balance Sheet

A few things stick out on the GFH balance sheet. Firstly, the assets held for sale. Netting off the assets held for sale with the liabilities held for sale we get to a net position of $45.5m (88.1m-42.7m) an increase in value from the $33.2m (see cashflow statement) paid for Leeds in December. A good result eh? Well, all is not quite what it seems... 
Looking at the investment property line, we see that the valuation has remained static throughout and a reading of the notes from the 2011 annual accounts details that the investment property is held on the balance sheet at cost, rather than fair value. Reading item d (iii) of the notes detailing basis of consolidation for associates (defined as entities in which the group owns more than 20% of the voting rights), it details that the investment is initially held at cost. This would suggest that the $45m value is comprised of $33.2m net consideration, due diligence and other acquisition costs of $1.5m and a further $10.4m of gain on acquisition of assets held for sale. I would guess that the $10.4m relates to the earlier working capital invested into Leeds over the course of last year and was recognised through the accounts once the acquisition was concluded. Hence  the gains from $33m to $45m is due to recognition of the full amount that GFH have spent to acquire Leeds United rather than a revaluation at fair value of the company.

Profit and Loss

Looking at the profit and loss statement, GFH made a profit of $10m, however this was largely driven by unrealised gains. If we strip out the following items:

• Gain on acquisition of assets held-for-sale
• Foreign exchange gain
• Impairment allowances

We get to a net profit of $4.6m. It's unclear whether share of profits of equity-accounted investees is an actual profit or a valuation movement, if it is a pure valuation movement then the net profit excluding non-cash items is -$349k.

Cashflow

Looking at the cashflow we can see that cash declined by $1.7m over the year. A large part of the cash provided to the business came through the issue of convertible murabaha during the year. I'm not an expert on shariah compliant financing but from what I have read, murabaha are essentially a form of asset backed security or effectively debt. This added $60.2m during the year. The other large source of cash inflow during the year was through the issuance of treasury shares. Treasury shares are essentially equity but generally without voting or dividend rights. The amount of treasury shares issued broadly tallied with the net cash paid of $33.2m. The difference I believe is related to the acquisition costs of the deal (lawyers fees etc). This would suggest that (as stated by GFH) the acquisition was paid fully by cash.

How does this impact Leeds United?

From what I can infer from the accounts:

• Leeds United was purchased with cash
• The investment is held on GFH's balance sheet therefore it is a GFH investment.
• The deal was financed by people injecting equity into GFH.

Having worked for an investment house for the last few years and dealing with different investment structures on a daily basis, this does seem like an odd way to hold the investment. Generally I would see an asset/investment held in a fund or special purpose vehicle, which would then be financed directly by the investors. The investment manager (GFH in this case) would then have a contract to manage the investment and may inject equity alongside. Here the asset is held directly on the balance sheet with the investor injecting capital into GFH to do the deal. They are therefore exposed to the performance of GFH as well as Leeds United. It therefore implies that the investor(s) are very comfortable with the future of GFH and for that to be true, it would have to either be someone with a controlling stake in GFH or someone who has managed to get themselves very comfortable with their business model. 

Risk for Leeds United?

I'm not an insolvency expert, but should GFH get into trouble, Leeds United as an investment shouldn't I think be impacted directly. The bigger threat would be  that GFH would be unable to provide further working capital to Leeds United. Given the deal has been financed by outside investors using GFH as a conduit, one would expect they would continue to fund it rather than write off the investment and risk wiping out substantial value. This would still be the case if the investment was held in an SPV or Fund.

Conclusion 

GFH's assertion on how the purchase of Leeds United was completed seems to correlate with the information in these accounts. It is clear (backed up by the analysis done by LUST) that Leeds United as a business was struggling to generate sufficient cash to meet its liabilities. The working capital injected by GFH has therefore been necessary to stabilise the ship. 

 

I can't determine if debt was also injected into the purchase at the Leeds United Holdings level, but what I would say is:

• Leeds United is struggling to generate sufficient cashflow, it is unlikely that they could service debt in addition to their current obligations.
• Given the history of Leeds and the limited number of assets, there are very few lenders who would provide financing. That is further backed up by Bates having to rely on factoring of season ticket and player sales in order to secure some form of financing. The idea that GFH would have levered their investment is therefore quite unlikely, and even if they were able to obtain finance, the terms are likely to be so expensive that it would not stand up from an investment perspective.

And in terms of GFH's future plans? Well, the fact that the investment is classified as an "asset held for sale" indicates that they expect to remove all or part of it from their balance sheet over the next year. This could be a sale (part or whole) to a third party, which ties in with the statements from GFH on their strategy.

Ultimately, there is nothing here which contradicts GFH's explanation of the deal to date, it is still unclear however who the ultimate backer of the deal is to buy Leeds United and their motivations, but assuming GFH are managing the deal, and are incentivised in line with general private equity fee structures, they will be heavily incentivised to make a good return from this investment or the fees earned by them will ultimately be quite miniscule. This requires them to make Leeds United a more successful and saleable entity than it is currently, and that alone provides me with some comfort.