Description

RECOMMENDATION:
I recommend shorting shares of Manchester United (ticker MANU).  It’s increasingly apparent that Alex Ferguson (MANU’s former manager who retired after the 2012/2013 season) was MANU’s “secret sauce,” allowing the team to achieve consistently top-notch on-pitch performance without spending as much as other rich clubs on acquiring star players.  Now that Ferguson has retired, MANU is facing the same calculus as other rich clubs: It must spend freely on players, and even then it will frequently suffer subpar seasons.

Over time, I expect MANU to become much like Liverpool – a competitive, rich team with a storied past, but one that generates revenue levels 35% lower than MANU’s and changes hands at 1.5-2.5x sales, instead of the 5.0x MANU currently trades at. 

For much of MANU’s trading history, it was a heavily-shorted stock with a high borrow cost, meaning it was difficult to short without a near-term catalyst.  Today however, short interest is less than 1% of the float, and it is a relatively cheap-to-borrow security.

COMPANY DESCRIPTION:

• Storied English football team ranking #3 worldwide in total revenue for 2014-2015 season
  • Since inception of Premier League in 1992, MANU has won 13 of 24 league titles
  • Under manager Alex Ferguson (who retired after 2012-2013 season), MANU won all of its 13 league titles and never finished below 3^rd place
  • In 3 seasons since Ferguson’s retirement, MANU has finished 7^th, 4^th, and 5^th, respectively

• Three sources of revenue:
  • Commercial (51% of LTM revenue):  Sponsorship (eg., fees for rights to place logo on MANU jersey), merchandising, apparel & product licensing, etc.
  • Broadcasting (27% of LTM revenue):  MANU’s share of TV revenue from the Premier League, Champions League, and other competitions.  MANU’s share of each pot can increase/decrease depending on on-pitch performance.
  • Matchday (21% of LTM revenue):  Ticket sales, parking, food & beverage, etc.

SUMMARY FINANCIALS:

Note that MANU’s functional currency is the GBP, but its stock price is quoted in USD.  Current stock price is $16.60, which equates to £12.83.  Enterprise value at the current stock price and exchange rate is £2457 million.

INVESTMENT THESIS:

Alex Ferguson was MANU’s “secret sauce”
Under Alex Ferguson’s stewardship, MANU enjoyed an unparalleled level of consistent on-pitch success while at the same time not spending as much on players as other high-level peers.

In his final ten years as MANU manager, Ferguson’s teams accomplished the following:
*Won the Premier League 5 times, finishing 2^nd 3 times, and finishing 3^rd twice
*Qualified for the Champions League every year, including one Champions League 1^st place finish

Ferguson achieved this success despite relatively modest player spending for a top-flight team.  Spending on players for European football teams comes in two forms: Wages paid to players (expensed as incurred), and transfer fees paid to the entity that owns a player’s rights (capitalized at time of signing and subsequently amortized).

In terms of player wages, in Ferguson’s final 3 seasons at the helm, MANU ranked #8 among all teams and #3 among Premier League teams in terms of average player wages:

Source: Sportingintelligence.com Global Sports Salary Surveys

In terms of player capex, in Ferguson's final 10 seasons at the helm, MANU ranked 5th among Premier League teams in average net player capex per season.  Generally, there is a strong correlation between player capex and on-pitch succcess.  MANU was a clear outlier in this regard under Ferguson:
Source: Transfermarkt.com for yearly player capex data

In the three seasons since Ferguson’s retirement, on-pitch performance has worsened while at the same time MANU’s player spending as increased substantially.

Every post-Ferguson season has has been worse than the worst season under Ferguson’s watch, and the team has only achieved Champions League qualification 1 out of 3 times (MANU will sit out the 2016/17 Champions League because of this year’s 5^th place Premier League finish):

After ranking #8 worldwide in player wages during Ferguson’s final 3 seasons, MANU has ranked #4 worldwide since:

Source: Sportingintelligence.com Global Sports Salary Surveys

After ranking #5 among Premier League teams in average net player capex during Ferguson’s final decade, MANU has ranked #2 since:

Source: Transfermarkt.com for yearly player capex data

Note the above and below charts do not include the spending bonanza MANU has undertaken this summer, when they’ve spent £170 million (equal to the entire last twelve months of EBITDA) to add three players to the roster.  As a result, I expect the trend of MANU being forced to allocate an increasing percentage of its revenue to player spending to continue:

Without Alex Ferguson, MANU is now facing the same calculus as other Premier League teams: to be the best you have to spend the most, and even then, you’ll still have occasional bad seasons.

Without their secret sauce, MANU is at risk of becoming Liverpool
The extremely consistent on-pitch success than MANU enjoyed under Ferguson benefitted the club’s owners both directly and indirectly.  There was a direct effect on the financials because the share of Premier League broadcasting revenue that a team receives is based on the team’s finish in the standings.  Even more importantly, finishing in the top 4 of the of the Premier League standings guarantees qualification for the following year’s Champions League and a share of lucrative Champions League broadcasting revenues.

As an example of the overall impact of Champions League qualification, we can look to the 2013/14 and 2014/15 seasons.  In 2013/14, MANU participated in the Champions League and generated revenue of £433 million, adj. EBITDA of £130 million, and adj. EBITDA less capex of £60 million.  In 2014/15, MANU did not participate in the Champions League and saw revenue fall 9% to £395 million, adj. EBITDA fall 7% to £120 million, and adj. EBITDA less capex fall 55% to £18 million.

On an indirect basis, consistent on-pitch success has long-term effects on the team’s brand value, which eventually impacts sponsorship and licensing revenues.  Under Ferguson’s watch, MANU’s unparalleled success allowed it to become one of the most valuable football brands in the world.  If success in less frequent going forward, I believe MANU’s brand value may eventually be tarnished.

There is perhaps some evidence of this already.  If we use Facebook “Likes” as a proxy for brand value, then MANU is still the #3 brand in the world, behind Barcelona and Real Madrid.  However, if we look at the growth in “Likes” over the past 18 months, it’s apparent that MANU’s popularity, now that on-pitch performance is weaker, is not increasing at the same rate as its peers’:

Source: Deloitte Football Money League publications, Faceboo

Will MANU eventually become similar in brand value to Liverpool, its biggest historical rival?  There are a number of similarities between the two clubs.  They have a similar history of on-pitch success.  MANU has won 20 Premier League titles, Liverpool has won 18.  MANU has won 3 Champions League titles, Liverpool has won 5.  Liverpool was the most dominant Premier League team from 1975-1990.  MANU was the most dominant Premier League team from 1990-2013.

While Liverpool is still a great brand, it is no longer a top 5 brand like it once was.  This is manifested in lower sponsorship opportunities (Liverpool will get ~£30 million from its shirt sponsor next year, vs MANU at  ~£55 million), lower shares of the Premier League broadcasting revenue pie, and lower overall revenue (Liverpool’s average revenue over the last 3 years is ~35% lower than MANU’s).

Liverpool’s brand strength is also manifested in lower valuation multiples.  Liverpool isn’t publicly-traded, but it was last purchased in 2010 for £300 million, representing 1.6x sales.  More recently, consortiums from the MidEast and China are rumored to have offered £700 million for the Liverpool, which would be 2.3x sales.  MANU currently trades at 5.0x sales; were it to trade at 2.3x, the stock price would be ~$6.25, ~60% below the current level.

MANU trades at a rich valuation on both absolute and relative bases
At the current USD stock price and USD/GBP exchange rate (MANU stock trades in USD but the functional currency is GBP), MANU trades at the following multiples (all based on LTM figures as of 3/31/16):

• 5.0x EV/sales
• 30x EV/EBITDA-capex (capex defined to include net purchases/sales of players)
• 61x P/E
• 3.0% FCF yield

On a relative basis, MANU trades well above all other publicly-traded peers:

*Based on prices as of 8/11/16 and LTM financials

If MANU traded at the same EV/sales multiple of its next highest peer, its stock price would be ~$11.05, or a third below the current price.  If MANU traded at the same EV/sales multiple of fellow Champions League contenders Juventus and Borussia Dortmund, its stock price would be below $3.

Publicly-traded sports teams have historically been terrible investments

There are at least 15 instances of soccer teams being publicly-traded (including Manchester United twice).  Of these 15 for which I have data, 13 have generated returns, since listing, below those of any relevant market indices, and 10 of the 15 have lost more than half of their market value since listing.

A common perception is that sports teams always end up selling for more than their owners paid for them; this may be the case for American sports teams, but it is not the case for European football teams, which operating under a different framework than American teams.  I suspect one of the reasons MANU chose to list its shares in the US rather than in the UK is because sports teams have a reputation among US investors of being solid financial investments.

Of course, the main outlier in the chart above is Manchester United itself, which generated outstanding shareholder returns from its original 1991 listing until is 2005 buyout by the Glazer family.  The reasons Manchester United was such a terrific investment during this period were that 1) the team went from middling on the pitch (at the time of its 1991 listing, Manchester United had gone more than 20 years without winning the league) to a juggernaut, and 2) the stock started from a low valuation (EV/sales at the time of its 1991 listing was only 1.1x, vs today’s 5.0x multiple).

RISKS:
Is new manager Jose Mourinho the next Alex Ferguson?

Jose Mourinho, MANU’s new manager as of earlier this summer, has an excellent managerial track record.  Over the last decade, he’s managed Chelsea, Inter Milan, Real Madrid, and Chelsea (again).   In those last 10 seasons, Mourinho has led his teams to 5 domestic league championships.

The knocks on Mourinho are that 1) he finds a way piss off others in the organization wherever he goes (explaining why he’s been forced out of a job 4 times in the last decade) and 2) his success has largely coincided with his teams spending league-leading amounts on player wages and transfers.

However, should Mourinho lead MANU back to a Premier League title in the upcoming season (and qualification for the Champions League in the following season), that could easily boost the stock.

New, more lucrative Premier League broadcasting deal taking effect this coming season
Broadcasting rights contracts for the Premier League typically last 3 years, and the next contract will start in this coming 2016/2017 season.  The aggregate sum over the next three seasons will be ~50% higher than the aggregate sum over the previous three seasons (15% CAGR from the midpoint of the prior contract to the midpoint of the new contract).  MANU has averaged £94 million in annual revenues from the prior contract, so the new contract should mean an incremental £40-50 million in revenue per year starting with the 2016/2017 season.

Much of this incremental revenue will be offset this coming season by the fall-off in Champions League revenues (since MANU didn’t qualify for the 2016/17 Champions League).  Moreover, I expect much of the increase in Premier League broadcasting revenues to translate to higher player spending and therefore will not fall to the bottom line.  MANU is already spending an increasing percentage of its revenue on player costs, and the new Premier League broadcasting contract will benefit all of the teams in the league, meaning that other bidders for players will have more to spend, thereby driving up the price of talent.

That said, MANU tends to trade more on a multiple of sales than of earnings, so any increase in revenue, regardless of whether it hits the bottom line, is a risk to the short.

In terms of other sources of revenue upside, note that new MANU’s shirt sponsorship with Chevrolet started in full in the fiscal year ended 6/30/15.  That deal paid them $70 million in USD last year, has 2.1% annual increases, and runs through the 2020/21 season.

Note also that the new Adidas apparel sponsorship started 8/1/15 so is mostly reflected in LTM financials already.  That deal pays £75 annually (no annual escalations) and runs for 9 more seasons.  However, the £75 million annual figure will be reduced by 30% if MANU fails to qualify for the Champions League 2 years in a row (if they fail to finish in the top 4 in the Premier League in the upcoming season, then the 30% cut will take place).

On the one hand, the recent Chevrolet and Adidas deals prevent revenue from falling too much for the next few years, assuming they can qualify for the Champions League at least every other year; on the other hand, they also prevent revenue growth from accelerating meaningfully and justifying the stock’s rich multiples.

Currency
MANU trades in USD, but the functional currency is GBP.   Should be pound depreciate relative to the dollar, it will be good for the short; should the pound appreciate relative to the dollar, it will be bad for the short.

Takeout

With a $3B USD enterprise value, MANU is a much less digestibly-sized acquisition than most other football teams (recall that potential buyers are offering £700 million, or less than $1B USD, for Liverpool), but with this type of asset, a takeout can never be ruled out.

Catalyst

• Disappointing on-pitch performance (failing to qualify for Champions League for second year in a row will trigger step-down in apparel sponsorship deal)
• Worsening profitability due to higher spending on players