Sporting and Business Worlds Collide

“You gotta keep the worlds apart” – George Costanza

For anyone who is a Seinfeld fan, the importance of keeping one’s different but important life interests, or “worlds”, separate should be obvious, serious, and hilarious. For those who don’t know the sitcom as intimately, a classic episode plays out where Jerry’s friend George Costanza (played by Jason Alexander) is devastated that Jerry has encouraged their mutual friend Elaine to spend time with George’s girlfriend Susan. George’s concern that his worlds, one of friendship and the other of amorous relationship, are coming together is exaggerated to astronomical proportions – and leaves the audience rolling in tears at George’s predicament, and at the same time worrying about their own worlds colliding.

This week we witnessed the sporting and business worlds collide full force when the Italian football club Juventus F.C. agreed to acquire the services of the Portuguese soccer player Cristiano Ronaldo dos Santos Aveiro, or Ronaldo to his friends. We think that the announcement provides an enjoyable opportunity to reflect on the economics of soccer (oxymoron or not?) through the case study of one of Europe’s super-clubs signing one of the best payers the world has ever seen. Let’s take a closer look at the club, the player and the economics of the deal all in turn.

La Vecchia Signora

Juventus Football Club, Juve to the fans, was formed by a group of students on a bench on Corso Re Umberto, one of the major boulevards in the centre of Turin, Italy. Over the next 120 years, Juventus would cement its place as the dominant club in the Italian league with 34 championships, and one of the most successful clubs in Europe.

At the same time Juventus has become the best supported team in Italy, with over 12 million tifosi, and one of the most supported football clubs in the world, with over 300 million supporters around the globe. Season after season these fans have had the pleasure of watching superstars like Zlatan Ibrahimovic, Pavel Nedved, Zinedine Zidane, Ronaldo (the original Brazilian version), Alessandro Del Piero and Gianluigi Buffon claim wins for I Bianconeri (the Black and Whites, named for the stripes of their jersey).

For most of Juventus’ history one Turin-based family has been pulling the strings. In 1923, Edoardo Agnelli, son of the founder of FIAT, gained control of Juventus and the club has remained within the family’s power ever since. Along the way the Agnelli family decided to share ownership of Juventus.

In 2001 the Agnellis listed shares of Juventus Football Club SpA on the Borsa Italiana, or Italian Stock Exchange. Today the family investment vehicle EXOR owns around 64% of the team, an investment fund based in the UK holds another 10%, and the general public (most likely die-hard fans) owns the remaining 26%. This means that Juventus has all the governance and disclosure responsibilities of any publicly-listed company, including the requirement to publish regular financial reports. We will come back to these later.

Indeed, Juventus (meaning youth in Latin) has become La Vecchia Signora (“Old Lady”) of Italian football; football more broadly; and, Turin and Italy in general, according to many observers. Yet as storied and wonderful is the history and legend of Juventus, the club faces stiff competition today. While Juventus is considered head and shoulders above the rest in Italy, coming off a seventh straight domestic league title, its position among European clubs is much less imposing. Juventus ranks around 9th in the top ten European clubs by annual revenue generation which means its ability to attract and retain the best players and market its brand to supporters around Europe and the world is constantly under threat in a highly competitive marketplace.

Ronaldo

Born in 1985 in Madeira, Portugal, Cristiano Ronaldo was diagnosed with a racing heart at the age of 15. He underwent surgery to treat the condition and a few years later, at the age of 18, signed with English powerhouse Manchester United. In six seasons with “Man U”, Ronaldo helped the team claim three Premier League titles and a European Championship. Astoundingly, but unsurprisingly, in 2009 Spanish super-club Real Madrid paid Manchester United a world record transfer fee at the time, of £80 million, for Ronaldo and agreed a contract with the player worth €11 million per year through 2015. When Ronaldo started his career with Madrid he was just 24 years old, but had already won the Ballon d’Or as the best football player in the world the previous season.

Since then Ronaldo has become considered by many commentators and fans to be the one of the best, if not the best, soccer players on the planet today, and perhaps of all time. Ronaldo has won a record-tying five Ballon d’Or awards (equal with Argentina’s Lionel Messi, widely regarded as Ronaldo’s only competition for the greatest ever accolade), five league titles, and five European championships. He has scored almost 700 goals for club and country.

Today, at the age of 33, Ronaldo is considered to be at the twilight of his career. Ironically, some would say he is playing at his best level ever. Ronaldo has just come off the 2018 season winning the European Champion’s League (again) with Madrid – something one might expect for a player supposedly earning in the order of €30 million a season, but not something considered usual or lasting for a man in his fourth decade – and appeared hungry for more. But that vision was not shared by Madrid’s powers that be, who must look beyond the next year or two, to build the Madrid and the Ronaldo of the future. In fact, it has been rumoured for years that club President Florentino Perez was looking to cede Ronaldo, and the financial obligation he comes with, to do just that.

The deal

So with Juventus looking for a boost to the club’s brand and revenues, and Ronaldo unlikely to be able to convince Madrid to keep paying him a lot of money for a long period of time into his thirties to have the opportunity to win more of the world’s biggest titles, the club and the player revealed an agreement this week to solve their respective desires:

Juventus agreed to pay Real Madrid €100 million for Ronaldo’s “registration rights”. As a quick aside, in football a player must be registered with a club to play in a competition. These registration rights belong to the club the player signs with for the duration of the playing contract. Since Ronaldo’s existing contract with Madrid lasts until 2021 the only way for him to play for another club is for Madrid to sign over his registration rights.

So, for the privilege of having Ronaldo in the team next year, Juventus were willing to pay Madrid to assume Ronaldo’s registration rights. Juventus were willing to pay Madrid a lot: €100 million. Actually, the bill came to €112 million after agents and other costs were paid. That’s right, for getting the deal over the line, Ronaldo’s manager would have taken a large share of that €12 million in “additional costs”.

On top of the one-time payment to Madrid, Juventus also had to negotiate Ronaldo’s employment contract which will run through June, 2022, and ensure Ronaldo has at least another four seasons of top flight football. According to journalist reports, Juventus agreed to pay Ronaldo €30 million per year for each of the four years of his contract term. To put that into context, Ronaldo will receive about A$1 million each week from Juventus. Think that’s a good earn? Well it gets better.

According to the reports, Juventus will ensure that Ronaldo earns his million-dollars-a-week without the burden of tax, which is paid at a rate of 50% in Italy, not dissimilar to higher income earners here in Australia. Juventus will pay €30 million each year to Ronaldo and another €30 million each year to the tax man on his behalf. That means Ronaldo’s equivalent gross pay is actually €60 million a year – just in case any readers are trying to do an apples-to-apples comparison to their own pay packet. Hint: don’t; you will feel very poor, even if you are very rich.

Why on earth would Juventus do this? Surely they have to get something out of it? Let’s see what they might be playing for.

For and Against

A quick look at the summary financials from Juventus’ 2017 annual report (the latest available given the financial year end June 30, 2018 report has not yet been published) lends credence to management and supporter claims: Juventus makes a profit. In fact, this has been true on a reported basis for the past three years. See the table below which shows Juventus summary accounts for the past five years.

But scratching the surface of the financials reveals a very different story. Consider the most recent financial year in which the reported revenues were €563 million and operating profit (before interest and taxes) was €67 million. In this year there was a stand-out revenue item of around €151 million related to “players’ registration rights”. The very same registration rights that we spoke about earlier in the piece. As another aside, let’s consider the accounting and profit impact of these rights.

When Juventus, or any team for that matter, acquires a player, like Ronaldo or really any player, they usually pay the transfer fee to the player’s existing club and book the cash outlay as an asset – not an expense – which they then depreciate over time. If Juventus, or another team, subsequently on-sells or transfers the player before the contract has expired it will receive a cash inflow and the difference between this inflow and the remaining value of the registration rights, the book value of the player, is booked as a gain in revenues. It’s a bit technical, so let’s just use an example.

In the 2017 financial year, Juventus sold star French player Paul Pogba to Manchester United for a €105 million transfer fee. But Pogba had been bought cheaply years earlier and had very little by way of value on Juventus’ balance sheet. Effectively the Pogba trade gave Juventus around €100 million of book profits in 2017.

Making some adjustments, in particular excluding these book gains and amortisation of player transfer fees, Juventus’ recurring revenues for 2017 were more like €412m, which means the operating profits were just €11m. The picture gets worse. Juventus owns its own stadium which requires ongoing maintenance which cost about €16m in 2017. Deducting this from operating profits means that on a steady-state basis in 2017 Juventus is actually in the red! What are the implications?

Quite simply, this means that Juventus is already paying out more than its revenues in costs. Revenues consist of TV and radio income, sponsorship deals, merchandise sales, and ticket sales on game days. Costs are mostly player contracts. Juventus paid its players (and technical staff) around €235 million in 2017, or 60% of total costs. So Juventus players are collectively taking all of Juventus’ revenues (after costs of services, products for sale, and maintenance expenses) and more such that there is no cash flow left over for Juventus shareholders – at least not in 2017, which by the way was the most profitable of the last half-decade in a reported sense.

Then along comes a superstar like Ronaldo. Deduct another €60 million on an annualised basis and, all else equal, Juventus will have to fund a significant shortfall for the next four years. A far cry from the profit goals that Juventus reports were claiming. And yet the situation gets worse when we look beyond just core profitability.

Remember, Ronaldo and all future star players that Juventus must sign come with a cash outlay or capital cost. Using the 2017 financial year as a case in point, Juventus spent €252 million acquiring players from other clubs. This is partially offset by the €193 million Juventus were paid to release some of their own players to other clubs. But still, the net result is €59 million out the stadium gates just in trading up the quality and celebrity of the player roster to stay competitive with the other European clubs – on and off the pitch. This figure was €103 million, net, in the prior financial year. So, for our financial analysis, we should deduct another say €60 million from the cash flows to get a true sense of the economics of running the club, which gives negative €120 million of normalised annual free cash flow to Juventus shareholders.

The starting point here is not pretty either. In addition to large cash outflows, Juventus has almost €300 million of net debt on the balance sheet. They will need to show the banks a path to better results if they are to rely on them to fund the cash losses ahead. That may be difficult.

The final piece of our analysis is concerned with the value Ronaldo might add to Juventus – after all, all of our analysis so far has been based on an all-else-equal scenario and adjusted downward for the cost of the Portuguese player. Where might he be additive to financial results?

Ticket sales? They make up just 14% of revenues. Juventus already pack out their stadiums each and every home game, and sell around three quarters of their seats before the season has begun. Prices go up a few Euro each year. Maybe they can raise prices a bitter quicker with the spectacle of Ronaldo, but it doesn’t seem like there is much benefit here.

Television revenues? They make up 57% of revenues. Juventus receives a split of national league TV revenues negotiated and distributed by the League. The association recently negotiated the Serie A league TV rights through 2021 and as the winner the past seven years in a row Juventus’ share is at a peak. On the European front the TV rights were also renegotiated through 2021 recently, and distribution depends on performance. In financial year 2017 Juventus made the final, so the club’s share here is also at a high. It doesn’t seem like there is much to add here either.

Sponsorship? The last big bucket of revenues, representing 18%, is made up of payments from corporate sponsors. The jersey sponsor is Jeep, the four-wheel-drive manufacturer, owned by Chrysler, itself owned by Fiat, in turn controlled by EXOR and a driver of more than half of that holding company’s value. Given the Agnelli family benefit from Jeep’s performance they may not be so keen to pay more for Juventus jersey real estate.

Jerseys? A smaller contributor to revenues at just 5% is the sale of merchandise including jerseys and replica kit. It has been estimated that Real Madrid sells the most jerseys annually at 2.3 million, and presumably Ronaldo’s number “7” shirt is the most popular. But there is a cost. The jersey manufacturer must be paid for the production and branding, so often the club retains as little as 30% of each sale. The take from a million jerseys sold at €100 apiece would only just cover the tax payments that Juventus have supposedly agreed to.

Juventus and George

With so many costs and outflows to accommodate a star like Ronaldo, yet few ways to recoup the investment through incremental revenue opportunities, it seems that once the rush of headlines slows, and the fanatical euphoria dies down, Juventus shareholders will be left to play the role of George Costanza. For them, and the shareholders and owners of many soccer clubs and sports teams alike, when the worlds of business and sports collide there may only remain a never-ending sense of worry – as both financial and emotional stakeholders – for years to come. This time without any of the laughs.

Screen Shot 2015-11-13 at 2.17.11 pm Christopher Demasi is a Portfolio Manager with Montaka Global Investments.
To learn more about Montaka, please call +612 7202 0100.

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Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

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Our Montgomery Global strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark. Branded as “Montgomery Global” in Australia to reflect a key.

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Our Strategies

Our Montaka Active Extension strategy strives for maximised return over the long-term. Owning the Montaka long portfolio typically scaled up to approximately 130 percent - and the Montaka short portfolio typically scaled down to approximately 30 percent – this strategy results in a net market exposure of approximately 100 percent most of the time.

Our Montaka variable net strategy strives for significant downside protection – but with minimal upside reduction. Focused on owning the world’s great and growing businesses when they are undervalued, while managing a portfolio of short positions in businesses that are deteriorating, misperceived, and overvalued, this strategy is our flagship long-short

Our Montgomery Global strategy strives to act as a core, high conviction, global portfolio holding. Consistent with the long portfolios in our Montaka strategies, this offering is focused on owning the world’s high quality, undervalued businesses – and cash when appropriate – to outperform its benchmark. Branded as “Montgomery Global” in Australia to reflect a key.