Long-term strategic ownership? A few thoughts on GFH's performance so far...

The question of ownership can often be controversial, especially when linked to something as emotive as a football club. The question of what or whom is a good or bad owner largely comes down to personal opinion and with Leeds and its recent history this is especially so. I personally stand with a foot in both camps. From a pure supporter perspective, the possibility of fan ownership or ownership by a supporters group is immensely attractive, but as a realist, working in the investment industry, I can see that a business such as Leeds United will always attract interest from professional investors.

It is very easy to class one or the other as a "good" or "bad" owner, arguably most football supporters would rightly argue that SISU Capital, owners of Coventry, or the Venkys would represent an example of bad ownership. However, for every SISU/Venky ownership, there is an ADUG, the Abu Dhabi investment consortium that bought Manchester City, or a Fenway Sports Group. In my opinion, there is no reason why an investment firm or consortium with no historical link to the club cannot be a good owner.

And so to the curious case of Leeds United. It is sometimes worth reflecting where Leeds have come from, something which has often been forgotten in recent months. If Leeds United was a patient a year ago, it would have been in intensive care, with the paddles charged and the Grim Reaper standing by the door. Rightly or wrongly, without GFH's or another outside party's intervention and capital during the course of last year, I strongly believe Leeds United would most likely have ended up back in administration. A cashflow dedicated to spurious building projects to the detriment (as critiqued brilliantly by Amitai Winehouse here) of the playing squad, and funded by debt and player sales had left us in a perilous position, and for taking us off the critical list alone, I for one will always be grateful to GFH.

It is one thing however to save a sick person's life, but its another to administer the medicine to cure them. For me, Leeds United as a business has the following issues which need addressing:

1. Poor cashflow generation: effectively the business isn't creating enough cash to support its activities
2. A lack of long-term strategic investment: A playing squad which has been chronically underfunded and plundered to support the cashflow rather than invested in.
3. Lack of engagement with the customer base: A customer base (the supporters) who have become disinterested in the product on offer.
4. Lack of stability and vision: Lack of clarity in the future of the business and its aims.

For me, GFH seem to have made good steps to address point 1 (which should largely be addressed should the remainder be sorted satisfactorily), to some extent point 3, and in my opinion it is too early to judge their performance against point 2.

In the short-term, it is point 4, a lack of stability and vision which is in danger of seriously damaging the club. For most businesses, It is not necessary for management to explain in detail to its customers how it is expected to move forward over the medium/long-term, however a football club, especially one with a fanbase as engaged as Leeds United, it is crucial.

Leeds United over the past 12 months has been dominated by uncertainty in terms of ownership which has continued under GFH with a variety of contradictory messages, with official statements professing a desire for "long-term" and "strategic" ownership, whilst releases to the stock exchange detail the desire for a short-term exit, and the involvement of investors who look to be keen to make a short-term investment return (see here). The long-term ownership and vision for the strategic direction of the club needs to be clarified and explained to a supporter base who have remained loyal in the face of disinterest for far too long. More importantly, no new manager of a sufficient calibre will be attracted to Leeds United without understanding and buying into the long-term vision of its owners. When said owner has the club as "held for sale" in their books, it does little to suggest a long-term and strategic approach.

Over the medium-term, point 2 in particular needs addressing, and to do so, Leeds United need to have an ownership structure in place with the necessary funds to invest for the long term in the playing squad, to enable the club to challenge effectively in the Championship, but also to attract the calibre of manager required to secure promotion. As can be seen from my earlier blogs, the financial statements released by both GFH and IIB raise concerns over the ability of both businesses to fund the strategic investment required by Leeds to take the club forward. There may be investors standing behind both enterprises willing to fund future investment but this is unclear, and given the high leverage of GFH in particular, one has to be concerned over the long-term viability of their business model. GFH Capital have often said they have a separate funding source to GFH and are therefore independent, however this is contradicted by the fact that Leeds United Holdings is held on the balance sheet of GFH.


Buying and running a business is difficult, buying and running a football club, with the constant attention and interest groups involved is exceptionally so, however I still think that Leeds United deserve a lot better than the status quo. Whilst I will always be grateful to GFH for removing Bates from the equation and for stabilising the business in a period of great uncertainty, I also believe that Leeds requires an ownership understands the history and legacy of the club, is prepared to engage with the fans on a more effective basis, and is able to outline a long-term strategic vision for where they hope to take the club.

Whether this is through a supporter-owned model or whether it is through a professional investment house which understands the nuances of our great club, I am relatively neutral, but it is clear that both financial capital and a vision are required to move us forward, and to ultimately build a successful football club, built on the support of an enfranchised and inspired supporter base. At this stage, it is doubtful to my mind whether GFH have the ability or vision to achieve this.

GFH and IIB - Long-Term Strategic Investment?

Last week saw GFH achieve the sale of a 10% stake in Leeds United Holdings Ltd to International Investment Bank (IIB), a Bahrain-based investment bank. David Haigh's comments at the time were as follows:

"The introduction of IIB is in keeping with what have always been GFH Capital's aims for the successful, sustainable and long term ownership of Leeds United FC.
"We believe that a consortium of like-minded investors provides the best ownership model for a club which belongs among the elite of English football clubs and global sporting brands.
"It is our aim to provide the finance and the stability to enable the club to complete that journey as soon as possible."

I'm going to come back to that statement in a minute, but first a brief look at IIB and their business activities. IIB was incorporated in 2003, and its core business areas are Real Estate, Private Equity and Structured Products. From looking through the portfolio of investments, the bulk seem to be real estate deals throughout Europe and the Middle East, with the private equity transactions predominantly confined to the Middle East.

David Haigh's comments above would indicate that IIB's investment in Leeds will be "long-term", "sustainable" and will provide the "finance and stability" to take the club forward. With particular focus on the "finance and stability" element, are IIB in a position to deliver this?  Looking at the Q4 2012 accounts (http://www.iib-bahrain.com/pdf/EnglishQ42012.pdf) provides some insight into the firm's financial stability and potentially also the ability to finance further investment in Leeds United.

Income Statement

If you strip out "gain on conversion of associate to investment at fair value through equity" (effectively a non-cash revaluation), we get to an operating loss of -$967,000 for 2012, an improvement on 2011's operating loss of -$2,565,000 but a loss nonetheless. Effectively we have a business whose core revenue (Investment Banking Fees) does not cover its Corporate and General and Administrative Expenses. This would indicate a business which is struggling to generate a profit through its core activities. Again however, it must be stated that this is an improvement from the position in 2011.

Balance Sheet
The balance sheet of IIB is in solid shape with limited debt putting pressure on the capital structure. It is unclear as to how their investments ($58.6m in total) are valued and whether this is hiding any losses, particularly on the real estate side.

Cashflow
For me the most troubling aspect of the business is their cashflow which shows a net cash decrease of $25,929,000 over the course of 2012 with a current cash balance of c. $35.5m. This is largely linked to investments made, but as can be seen from the income statement, the business is not generating cash and therefore its sustainability is down to support from outside sources (either investors through equity or debt).

This may be readily available, but it does raise a question mark over their ability to continue to sustain investment in their transactions and does to my mind create questions in terms of their ability to provide "finance and stability" to Leeds United.

With Warnock's comments indicating that GFH need to sell shares in order to fund investment in the club, and Haigh's comments above, this may be the first of many share sales in Leeds United. With the outcome of any proposed investment by Steve Parkin at the time of writing this uncertain, what would the implications of having a consortium with multiple investors, invested in Leeds United?

From personal experience, investment consortiums can be incredibly tricky to maintain and manage for anything but a medium term investment horizon and must generally be governed by a firm legal framework and stringent business plan.

For a business such as Leeds United, which requires investment and stabilisation, not to mention having to deal with the vagaries of the performance of a football team (whose performance can to a reasonable extent be governed by chance), it can be difficult to maintain a cohesive vision amongst all parties, especially when some/all of these parties who are investment banks and therefore might have different investment targets, hold periods and ability to fund further investment on an ongoing basis. As a Leeds fan, any attempt to stitch together a consortium of multiple parties of a similar ilk would particularly worry me, especially when it is unclear in terms of their ability to provide long-term sustainable investment into the club.

To my mind, the following is clear:

1. Leeds United today is a club for sale and one which requires further investment. This breeds uncertainty and will make it difficult to attract both the manager or players required to mount a successful promotion bid.
2. GFH need to sell down their stake (either fully or partially) over the short to medium term.
3. Given how this season has turned out, and the need to attract a new manager with a proven track record to replace Neil Warnock, a sustainable consortium/pool of investors will need to be in place before the end of the season in order to maximise the opportunity of next season.

I still retain some faith that GFH will take the necessary steps to ensure that the club is put on a sustainable footing, and that much of the work they have done to date has improved things compared to the Bates era, however the uncertainty over the club's ownership is unsustainable with the investment of IIB doing little to improve the status quo. The longer it is allowed to drag on, the more damage will be done to our prospects for next season and even from GFH's perspective, this is surely untenable.

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.