One Possible Method for Buying Elland Road.
I’ve been asked at various times to explain why I love Balance Sheets so much and now that Mr Radrizzani may be about to buy Elland Road through a new, separate company under the Leeds United Group this may be a good time to do so.
Here I look at how the finances of this new company may progress and how they will affect its Balance Sheet. Let’s call the new company ER-Co Ltd (this could be the parent company Greenfield Investments PTE or a new entity owned by Greenfield).
A perfect Balance Sheet is one that is BALANCED as in this graphic.
When ER-Co is first incorporated the Balance Sheet will be blank and so be in perfect balance, like the graphic. Since Mr Radrizzani intends to use this company to buy Elland Road this company needs some money – so Radrizzani gives ER-Co £1m.
This goes onto the Assets side of the Balance Sheet:
Now the Balance Sheet is Out Of Balance so something must be wrong. We’ve forgotten that when Radrizzani gives the ER-Co money it is either a loan or share equity. This first £1m is likely to be share equity and the ER-Co will give Radrizzani 1m shares in return – this means that if ER-Co is liquidated in the future he is owed funds and therefore this share entry goes on the liabilities and funds side.
The Balance Sheet now balances again so all is well.
However, ER-Co needs more than just £1m to buy Elland Road so let’s say Radrizzani lends the company £7m and some of his Chinese friends lend the company £10m. The cash in ER-Co’s bank account gets another £17m and now has £18m in total.
The Asset side is now loaded up with more cash and is showing as Out Of Balance again – something is wrong! We’ve forgotten that when money is lent to ER-Co that money must be paid back at some time and so is a liability for the company.
Now we are back in Balance so all is good.
Next thing is ER-Co will buy the stadium back and pay Teak Commercial £17m – obviously £17m comes out of the bank.
And lo and behold we are Out Of Balance again.
Although we have much less cash we do own a stadium and the value of this in an Asset to ER-Co.
This brings it back to Balance again and I’m happy!
The problem this company has now is that it owes £10m to Chinese investors and £7m to Radrizzani that must be paid back at some time. Radrizzani may well not be concerned about getting the money back immediately but the Chinese will want repaying and they will also want to get interest on the loan. I’m going to say the Chinese want £1m repaid every year and 5% interest so ER-Co needs to find £1.5m in the 1st year.
ER-Co needs income and so will charge LUFC rent for using the stadium – I’m going to say ER-Co charges LUFC £1.2m rent. When LUFC pays this rent the bank balance goes up so total assets goes up.
We are again Out Of Balance so we need something to go on the other side. What has actually happened is that ER-Co has made a Profit by charging rent – this Profit belongs to Shareholders and is classed as Shareholders Funds.
Again we are back in Balance but haven’t repaid the Chinese the first instalment of their loan yet. We need to pay them £1m from the loan plus £500,000 interest. First of all we take £1.5m cash out of the bank:
This makes it Out Of Balance but we are still showing the Chinese loan as £10m even though we’ve repaid £1m of the loan. So we can reduce the amount owing to the Chinese.
Note we are still showing Out Of Balance with £17.7m on one side and £18.2m on the other – this is because we paid the Chinese £500,000 interest from the Asset side but haven’t made a change on the other side: when we pay interest it is a cost to the company and reduces Profits – so we need to reduce the Profit figure by the interest figure.
Now we are back in Balance with £17.7m on both sides and we’ve finished the first year’s accounts.
When we go through the all of the same procedures for the second year we get another £1.2m rent, repay the Chinese £1m from their loan and also pay the Chinese £450,000 interest.
Since we’ve accounted for everything properly everything balances again.
However, there are some worrying things to note here: the company is profitable and has made £1.45m in its first two years but it started with £1m cash in the bank and now only has less than half a million left. This shows how Profit and Cash are not directly related.
Let’s fast forward another 8 years and the Chinese loan is all paid off: in this example the ER-Co almost ran out of cash but just survived.
The Balance Sheet balances with £17.25 on both sides so we know everything is good – the ER-Co has made over £9m profit but has spent all its cash repaying the debt owed to the Chinese.
Now that the debt has gone the next few years will start to generate cash. Let’s look at the position after another 6 years:
As expected we are now generating cash and can repay Radrizzani his entire loan back but without any interest – we take £7m cash out and cancel the £7m debt:
So let’s take stock of what’s happened: the Chinese who loaned money to buy Elland Road have got all their money back and got a nice 5% interest bonus on top; Radrizzani has got his loan money back but didn’t get any interest payments so he’s gained nothing, he’s also still not been repaid for the shares he bought.
If Radrizzani doesn’t gain any return on his £7m loan why would he invest at all? – the answer is that he owns the stadium and he can sell it and make money from doing so.
Let’s assume that after 16 years Radrizzani decides to sell up and a new person buys the club and wants to buy the stadium as well. The first thing that will happen is the stadium will be re-valued to represent its market value in 2033. I’m going to randomly guess that to build a similar stadium in 2033 would be £200m: this would be for a brand new, up-to-date stadium whereas Elland Road would be an old stadium with various upgrades but still needing work done; therefore we could say a fair market value of an older stadium is half that of a new stadium and re-value Elland Road as £100m.
Again we’re Out Of Balance – the extra valuation is basically Profit (an accountant would call it a revaluation reserve but it is essentially profit) so the correct Balance Sheet is:
So now ER-Co knows how much to ask as the selling price of Elland Road and when it sells it gets £100m cash but no longer has ER as an asset:
Radrizzani now has a Shareholders’ Funds pot of his original £1m shares plus £99.45m profit – there is enough cash in the bank to pay the shareholders this entire fund so Radrizzani walks away with £100.45m in his pocket as a bonus and closes ER-Co down.
So Radrizzani loaned £7m and invested £1m in share equity and ended up with a total of £107.45m.
Not a bad return!
Disclaimer: this story is just one possible scenario for what could happen and is designed to explain balance sheets – it does not mean that Elland Road will be bought or funded this way, nor does it mean this is what I recommend.
23rd June 2017