Porto's Buy Low, Sell High Strategy

When football fans witnessed Barcelona’s dazzling 5-0 demolition of rivals Real Madrid, they would have been forgiven for assuming that this was an unprecedented performance, but they would have only had to look back three weeks for a similar exhibition in Portugal, when Porto crushed Benfica 5-0 at the Dragão Stadium. The country’s most successful team of recent times thrashing its celebrated capital city opponents? Check. Inspired by a South American phenomenon? Check. Guided by a progressive young coach? Check.

After finishing a disappointing third in the Portuguese League last season, Porto replaced their coach Jesualdo Ferreira with André Villas Boas, a protégé of José Mourinho. Although this is his first coaching role at a leading club, the 33-year-old has already stamped his authority on the team, which has played some beautiful, free-flowing football this season. So much so that Porto are unbeaten in the league, which they lead by an astonishing eight points after 13 games, and are very much favourites to regain the title.

Their inspiration has been a young Brazilian striker named Givanildo Vieira de Souza, better known to the football community as Hulk, largely due to his powerful physique. His presence was badly missed by Porto last season, after he was suspended for a few matches for his part in a post-match brawl following an ill-tempered match against Benfica, when he was found guilty of attacking match stewards in the tunnel. His goals might have made all the difference to Porto in the championship run-in and would almost certainly have avoided the ignominy of failing to qualify for the Champions League for the first time in living memory.

"Andre Villas Boas - remind you of anyone?"

This represented a slap in the face for a club that has become accustomed to filling its trophy cabinet in the past few years. Before 2009/10, Porto had been victorious in the Portuguese championship four consecutive times, which meant that they had collected six Primeira Liga titles in seven seasons. Their history in the last decade also features two European successes under the guidance of the Special One, when they beat Celtic 3-2 to secure the UEFA Cup in 2003 and triumphed 3-0 against Monaco to win the Champions League the following year.

Unfortunately, during this period the club was also tainted with the whiff of scandal for its involvement in the so-called “Golden Whistle” investigation, when it was claimed that referees were offered bribes before two of their matches during the title winning campaign in 2004. They were subsequently docked six points and fined €150,000, though some thought they had got off rather lightly. Importantly, they were still allowed to compete in the Champions League, even though they were initially banned, as on appeal the authorities ruled that the time limit for dealing with the match fixing allegations had passed.

All in all though, the “noughties” has been a highly enjoyable era for Porto. Their success on the field of play has been matched by their performance off the pitch, as the club has reported profits in each of the last four years, which is very good going in these difficult economic times. Although the club tends to make sizeable operating losses, it more than compensates for the shortfall by making equally large profits on player sales.

This is a hugely important activity for Porto’s business model, which can most clearly be seen in 2006, which was the last time the club made a loss, almost entirely due to the club’s decision to retain players that year in order improve their chances of winning. Similarly, the 2010 profit of €0.1 million was €5 million lower than the previous year, which is more or less the reduction in profit on player sales.

The other key driver in Porto’s finances is revenue from the Champions League. Indeed, the €10 million reduction in 2010 revenue was largely due to the team’s earlier exit from that competition. However, Porto are very skilled at balancing their books, so they compensated for most of the decline in revenue by cutting their costs by €7 million, mainly in the wage bill, though they were also helped by €3 million lower interest payments, due to the reduction in interest rates.

Porto’s cash flow from operations (EBITDA) is fairly healthy, averaging €33 million over the last four years, once non-cash items like player amortisation and depreciation are added back, but this is again very reliant on the profit made from player sales. If this were excluded, then EBITDA would be slightly negative.

Although president Jorge Nuno Pinto da Costa has been criticised by some supporters for the club’s policy of selling their best players year after year, a cursory glance at the financials is enough to understand why this approach is necessary. The relatively low revenue, combined with wages high enough to remain competitive, mean that Porto need to make money in the transfer market to survive. They have been remarkably consistent in the profits they have managed to generate from this activity in recent years: 2008 €35 million, 2009 €40 million and 2010 €35 million. They are well on course to repeat the trick in 2011 following this summer’s sales of Bruno Alves to Zenit St. Petersburg for €22 million and Raul Meireles to Liverpool for €13 million.

The numbers are simply incredible for a club of Porto’s size. Since that Champions League win in 2004, the club has raked in almost €350 million revenue from player sales, though its net surplus is “only” €190 million, as it also spent €160 million on buying players in the same period. Looking at this another way, Porto have spent a lot on buying players, but have made even more on selling them. In fact, in the last 11 years, only twice have Porto had a (small) net spend in the transfer market and that was way back in 2002 and 2004.

They are absolute masters at selling two or three players every season for big bucks, interestingly often as bulk purchases, e.g. three players to Dynamo Moscow and two to Chelsea, though the latter sales were obviously partly down to Mourinho raiding his former club. The list of players transferred for over €5 million since 2004 is an extensive one:

The club has demonstrated the enviable knack of buying players relatively cheaply, benefiting from their prowess for a couple of seasons, then selling them for a very good price to richer European teams. As the annual report explains, “We clearly bet on the training of talents and the early detection of the best players.” That’s a fine objective, but it would be to no avail if they could find no buyers, but even in a subdued transfer market, Pinto da Costa boasted, “our assets were again the most requested on the international scene.”

Much of this is down to Porto’s world-class scouting network, which is especially formidable in South America. They need to search far and wide for promising prospects, as they cannot afford to pay top dollar for foreign players, though they address this financial weakness in an innovative way by sharing the player’s rights with an agency, which means that they do not have to fund a transfer in one fell swoop.

For example, in April 2005, Porto bought 50% of the sporting rights of Lisandro Lopez (from Racing Club) and Lucho Gonzalez (from River Plate) with the remaining 50% only acquired in season 2007/08. Clearly, this type of deal is a double-edged sword, as it means that any future profits are shared proportionally with the agency, but it does reduce Porto’s initial outlay and de-risks their activities in the transfer market.

"Bruno Alves - To Russia With Love"

Even though Porto cannot afford to pay very high wages, they still have much to offer South American players. Not only is Porto itself a very successful club, their regular participation in the Champions League provides a perfect platform for emerging talents to display their wares. Moreover, players can easily obtain work permits and embark on the path towards a EU passport, which makes them a more attractive prospect to clubs in countries with more restrictive regulations. Finally, Brazilian players do not have to struggle with any language issues.

On the flip side, Porto are forced to reinvent themselves every season with no player being considered irreplaceable. In this way, when Carvalho left for England, he was replaced by Pepe, whose exit was compensated by the emergence of Bruno Alves. Even with this massive turnover of players, the club has managed to maintain its successful record, consistently winning the Portuguese league, though arguably the departure of three key players to France in the summer of 2009 was a bridge too far.

In the same way that Porto often buy a percentage of a player’s rights, they sometimes also sell part of a player in order to raise cash. There was an example of such a trade only last month, when the club sold percentage of three recent arrivals for a total of €8 million (37.5% of Joao Moutinho, 35% of James Rodriguez and 25% of Walter).

"Falcao - no, not that one"

They also often structure their transfers in a way that they can share in a player’s future development, e.g. Aly Cissoko’s deal with Lyon included a 20% sell-on clause, while the agreement with Lyon for Lisandro Lopez could be worth an additional €4 million depending on sporting achievements. While hesitating to use the phrase “wheeler dealers”, Porto are definitely very nimble on their feet in the transfer market, leaving many of their more illustrious (and staid) peers in the shade.

Ironically, given the vast sums that Porto received from Lyon in 2009, the French club is often considered to operate a similar business model, sharing many of the characteristics of their approach to the transfer market. Up until the last two years, that was certainly the case, before Lyon embarked on a spending spree of their own recently, though their president has promised that they will revert back to type in the future. Furthermore, in relative terms, Porto are even more reliant on money made from player sales, due to the fact that Lyon enjoy a far higher turnover.

This is the essence of Porto’s problem, for the club is a big fish in a small pond. The Portuguese market is a small one with many clubs struggling financially, so the only realistic way for Porto to keep up with Europe’s elite from the wealthier nations is to sell the players that they develop. In that way, they can just about find enough money to fund a wage bill that will allow them to be competitive.

We can see the magnitude of the problem by examining the Deloittes Money League for 2008/09. There’s not a Portuguese name in sight among the top twenty listed, which is no surprise given that Benfica is the only Portuguese club to make an appearance on this august list, back in 2006 (in 20th position). Porto’s revenue of €68 million in 2008/09 leaves them miles behind wealthier clubs. To place that into context, Real Madrid’s revenue of over €400 million is almost six times as much. Even a club like Newcastle United, which was relegated at the end of that season, generated 50% more money.

This highlights the enormous financial challenges confronting clubs from outside the Big Five countries (England, Spain, Germany, Italy and France). By a strange coincidence, Porto’s revenue is almost exactly the same as that of Ajax, who face the same sort of issues. In terms of Premier League clubs, the nearest revenue equivalent is Stoke City, who have made a lot of progress recently, but, with the greatest respect, their record is nothing compared to Porto’s. From that perspective, there is no doubt that Porto have been punching well above their weight in Europe, regularly reaching the last 16 of the Champions League.

At this point, I should probably clarify that this analysis is based on Porto’s consolidated accounts, which include the following companies: PortoComercial (sponsorship, licensing and merchandising, 93.5% owned), PortoEstadio (stadium, 100%), PortoMultimedia (70%) and PortoSeguro (insurance, 90%). That said, the results are still very largely based on the operations of the football club.

The importance of player trading to Porto’s business can be seen very well in the above graph. If profit on player sales is considered as “revenue”, its contribution has been notable in the past few years, averaging around 60% of normal turnover. Put another way, the club makes three times as much from the transfer market as gate receipts. This would be very worrying if Porto had not shown that they are capable of maintaining this “revenue stream” year after year, with the exception of 2006, when, of course, the club made a big loss.

It is imperative that Porto continue along this path, as the revenue growth in other areas has been very limited. Gate receipts are actually down 17% in the last five years, while television, the impetus behind revenue growth in many countries, has only risen €5 million in the same period. The star performer has been commercial income, which has doubled to €24 million. Although total revenue growth of 24% has outpaced cost growth of 19%, the absolute growth is smaller, meaning that the operating loss has slightly grown over this time. Whichever way you look at it, the club needs to buy and sell.

As we have seen, broadcasting is not as important for Porto as other leading clubs with the 2010 revenue amounting to only €20 million, comprising €8 million from the domestic deal and €12 million distributions from UEFA for the Champions League. Even with the boost of European revenue, which represents over half of their total TV revenue, this is fairly pitiful compared to the major leagues. If we compare Porto’s revenue with the clubs that earn most from broadcasting income in those other leagues, we can see that they earn between four and eight times this amount.

The total value of the Portuguese Liga TV rights is only around €50 million a season, which compares very unfavourably to others: England €1.2 billion, Italy €900 million, France €700 million, Spain €500 million, Germany €400 million. That might be expected, but the Portuguese contract with Olivedesportos (matches shown on SportTV) is also behind Turkey €250 million, Holland €100 million and Greece €54 million. This is not a collective deal, so the lion’s share of the TV revenue (about €24 million) goes to the traditional big three clubs in Portugal: Porto, Benfica and Sporting Lisbon.

From that perspective, Porto’s €8.4 million is not too bad (up from €7 million in 2008), but to put this into context, Arsenal also finished third in their league and received around €62 million, which is nearly eight times as much - and the Premier League TV money will further increase this season. In fact, Arsenal on their own received more than all of the 16 clubs in the Portuguese Liga combined.

That’s why the Champions League money has been so important to Porto’s finances over the last few years. This is most evident in 2004, the year when they won the tournament and received €25 million, which was almost 40% of their turnover that year, but even this year when the revenue was down to €12 million, that was still worth 20% of their income - and that excludes gate receipts and sponsorship increments.

Porto use a slightly strange accounting policy when it comes to reporting Champions League revenue, whereby as soon as they have qualified for the competition, they immediately book the guaranteed element for the following season. So the 2009/10 revenue for participating in the group stage (worth €7.1 million) was already reported in 2008/09, hence the reduction in the 2009/10 accounts, even though Porto actually received more from UEFA that year: €18.7 million in 2010, up from €14.5 million in 2009.

What is certain is that qualification for the Champions League has been fairly lucrative to Porto, €92 million in the last seven years, though they have again been short-changed because of their misfortune in playing in a small country, more specifically a country with a small TV audience.

"Happy days for Varela"

Although Champions League participation fees and performance prizes are the same for every club, the share of the television money from the market pool is dependent on the size/value of a country’s TV market, so the amount allocated to teams in other countries is more than that given to Portugal. For example, last season Porto reached the last 16 and received €5.4 million from the market pool, which was much less than the €18.1 million distributed to Chelsea for reaching the same stage.

Actually, Porto’s share of the 2009/10 pool was higher than they are accustomed to receiving, as the allocation also depends on the number of representatives from a country that qualify for the group stage, and there was only one from Portugal that year, compared to two or even three in previous seasons.

Porto’s bottom line will therefore be adversely impacted in 2011, as they have only qualified for the Europa League, which distributes much less money than the Champions League with the guaranteed fees worth only €1 million. In fact, if Porto were to battle their way through countless matches and win the trophy, they would still only get €6.4 million, though that’s better than nothing.

"25 million for Quaresma?"

Hence, the determination that the club’s absence from the Champions League will last no more than a year. Only first place in the Liga ZON Sagres guarantees qualification, but the runners-up can also get there if they make it through the qualifying matches. The latest UEFA coefficient rankings suggest that Portugal may get a third place from next season, which would give Porto an even better chance of returning to Europe’s premier competition. That would obviously please their fans, but it would no doubt also bring a smile to the face of their bank manager.

And there’s more: as the 2009 annual report stated, “In addition to the direct financial results awarded by UEFA, the presence of FC Porto in the great showcase of European football, where players strongly shine, is essential to their valorization as economic assets of the society.” Not the greatest translation in the English version of Porto’s accounts, albeit scoring high marks for lyricism, but, in short, this means that the Champions League is also the perfect shop window for Porto’s selling policy.

Where Porto have done quite well is in increasing their commercial revenue, especially sponsorship and advertising, which has reached €14 million. They have an interesting shirt sponsorship deal with Portugal Telecom, which features one company tmn (mobile network) on the home shirt and another meo (IPTV) on the away shirt in the same way that Arsenal used to have Sega and Dreamcast on different kits. This is a long-term six-year deal worth €21.45 million and runs until June 2011.

However, this is still on the low side by international standards, equivalent to only €3.6 million a season, while Bayern Munich, Manchester United and Real Madrid all have deals worth over €20 million. It might seem absurd to make comparisons against clubs of this stature, but Porto will have to beat these teams if they want to lift the Champions League trophy again.

Similarly, the kit deal with Nike brings in less than €3 million a season (four-year deal worth €11.1 million, potentially rising to €14.8 million depending on team’s success, for the period 2008-12). Although Porto have been very active in merchandising initiatives, including revoking an agreement with TBZ following poor performance and setting up several club stores (co-branded with Nike), revenue from this source only comes to just over €2 million a year. A similar amount is generated by corporate hospitality, which is contracted out to a company called EuroAntas.

Gate receipts are also nothing to write home about at just €11 million, which is the lowest that they have been in the last six years. The €2 million decline is partially attributed to the earlier Champions League exit with the previous season’s glamour quarter-final against Manchester United bringing in €0.9 million alone, but is also symptomatic of the general economic malaise affecting Portugal, which resulted in the average league attendance falling 14% from 38,800 to 33,500. The poor results probably also played a part, as the average so far in the current successful season has climbed back up to 37,800, which is just behind Benfica, who have the highest crowds in Portugal at the moment.

However, as we have seen, this does not produce much in cold hard cash with the gate receipts being worse than every club in the Deloittes Money League. There may be some match day income hidden away in commercial revenue, but the harsh reality is that the club’s revenue here lags a considerable distance behind its foreign competition. Manchester United’s match day revenue of €128 million is about ten times higher than Porto’s. It’s difficult to compete with such financial might, especially as this difference accrues every single season.

The club is housed at the Estádio do Dragão (Stadium of the Dragon), which replaced their old stadium, Estádio das Antas, in 2003. It seats over 50,000 spectators and its name is derived from the dragon on Porto's crest, which is also the nickname of Porto fans. The new stadium was built for the European Championships held in Portugal in 2004 and cost €98 million, of which €18 million was contributed by the taxpayer. To further support the funding, naming rights have been sold for each stand, mainly to divisions of the principal sponsor Portugal Telecom, but also to other companies like Coca-Cola.

The stadium is actually owned by EuroAntas, which granted Porto a 30-year lease in 2003 to use the facilities for an annual payment of around €1 million. It is also used for other events like the “Race of Champions” featuring the top drivers in motor sport. In addition, the complex features a multi-sport arena nearby for Porto’s basketball and handball teams.

"Enter the Dragon"

Moving onto costs, even though expenses are higher than revenue, it is clear that Porto strive to reflect any movement in the revenue in the costs line, so when revenue surged 24% in 2009, costs grew by a similar amount 25%. On the other hand, when the 2010 revenue fell 15%, cash costs (excluding player amortisation) were also cut by 14%. This is a tough balancing act, as the wages have to be held at a minimum level in order to attract the right quality of player.

As the annual report explained in its quaint English, “the company bets on the investment of the team with players of high quality … to ensure the best sporting results, which necessarily requires adequate compensation to their status.” Nevertheless, Porto’s wage bill of €39 million is very low by international standards, a long way below big spenders like Barcelona €263 million, Inter €205 million, Real Madrid €187 million and Bayern Munich €165 million. An interesting equivalent would be Celtic, but even their wage bill of €43 million is higher. Of more interest to Porto fans might be the wages of Arsenal, the team that eliminated them from the Champions League last season, which are €130 million – over three times as much.

Wages actually reduced 17% in 2010 from €48 million to €39 million, partly due to worse sporting performances, which resulted in lower bonus payments. Porto have stated that 25% of staff costs are related to the performance of the team, so in a good sporting year, these costs will increase ceteris paribus. The split of this year’s staff costs is: players €23 million, technical and administrative staff €10 million, directors €2 million (on the high side), insurance €1 million, other costs €3 million.

Porto also specifically mention in their annual report the Webster Law having an inflationary impact on salaries. This regulation allows a player to unilaterally terminate his contract after three years (or 2 years if he is over 28) to move to a foreign club, only compensating the club with a sum equivalent to the remaining salary for the time left on his contract. Clearly, that could spell disaster for Porto’s business model and its reliance on money from player sales, hence the decision to raise salaries in 2009.

Given these pressures, the club is justifiably proud of keeping its wages to turnover ratio below UEFA’s recommended upper limit of 70%. This ratio actually fell to 68% last year, which is very impressive if you consider the constraints imposed by the low revenue.

The trend in player amortisation, namely the annual cost of writing down the cost of buying new players, is more concerning, as this has been steadily rising over the last two years. In the four years between 2005 and 2008, it had held steady at around €20 million, but it has now shot up to €27 million. Of course, this can quickly be reduced with the sale of a couple of players that were bought for high fees, so I would expect this trend to reverse in the near future. In any case, it’s still much lower than those sides that have spent really big in the transfer market, such as Manchester City €83 million, Barcelona €71 million, Real Madrid €64 million and Chelsea €57 million.

Like most other Portuguese clubs, Porto have a lot of debt. Given the imbalance between expenses and revenue, this is hardly surprising, but it is exacerbated in their case by the cost of building the new stadium. That said, the debt is still on an upward trend, though it has remained at €84 million for the last two years. This comprises €76 million of bank loans plus a €17 million bond less €8 million of cash.

According to the annual report, “the company managed to relieve the financial pressure by issuing a new bond.” This bears 6% interest per annum and is repayable in December 2012. What was reassuring is that the bond issue was 4.5 times over-subscribed, reflecting the market’s support for the club. This is not the first time that Porto have tapped the debt market, as they issued a similar three-year bond in 2006, which was repaid on schedule in December 2009.

Of more concern is the security provided to guarantee the loans with the accounts listing all sorts of collateral, including Champions league revenue, stadium naming rights, sponsorship contracts and transfer receivables. The club is obviously aware of this issue and stresses that it can service the debt by referring to the net debt/EBITDA ratio. In Porto’s case, this works out as 2.7 (84/31), which is not great, but I’ve seen worse. The ratio effectively indicates how many years’ earnings would be required to pay off all the debt and is considered alarming if it rises above 3-4.

"A special day"

The other aspect of debt that is important to clubs like Porto with their frenetic activity in the transfer market is how much they owe to other football clubs, which stands at €25 million. This is in line with previous years: 2008 €23 million, 2009 €26 million. However, other clubs owe Porto more than twice as much with an incredible €56 million of receivables. This appears to be a vital part of Porto’s transfer dealings, as the sum is unchanged from last year, while 2008 was also high at €46 million. The largest debtors are Lyon €12 million, Marseille €10 million and Inter €6 million. Porto supporters might be surprised to know that the club is still owed money two years after the sale of Quaresma to Inter.

This is one reason why Porto’s balance sheet shows €23 million of net assets with assets of €183 million being higher than liabilities of €160 million. The surplus is partly due to the value of player registrations held on the books, which increased last year from €58 million to €69 million. Of course, this accounting value is significantly below the players’ market value, which has been estimated at €132 million by Transfermarkt. In particular, players developed by Porto’s academy will have zero value in the accounts, but are obviously worth something.

However, there are risks facing Porto’s strategy, as the transfer market has been deteriorating recently, with all clubs affected by the recession, and values of players have plummeted, e.g. Zlatan Ibrahimovic’s price was slashed to €24 million just 12 months after Barcelona paid €70 million, while Diego moved to Wolfsburg for €16 million a year after Juventus bought him for €25 million. The statistics show that Europe’s top five leagues spent almost 40% less on transfer fees in the summer of 2010 than the previous year.

"Meet El Presidente"

On top of the adverse market environment, the advent of the UEFA Financial Fair Play Regulations could also have a detrimental effect. These will force clubs to break-even if they wish to compete in European competitions, so expenses have to be covered by revenue. As a major expense element is the player amortisation arising from transfers, it seems logical that clubs will endeavour to reduce their transfer spend, which might well harm selling clubs like Porto.

Having said that, Porto have managed to beat the odds so far with the transfer of Bruno Alves this summer among the top ten worldwide. Maybe it just means that only those clubs with superb scouting networks and an excellent track record for developing players will thrive in the new world – and Porto certainly fit the bill there. It is clear that they still have many players who would be in demand with Manchester City being only one team linked with a €30 million move for Hulk.

Even so, it makes it even more important for Porto to produce players from their “Dragon Force” academy, as the club may have less money in the future to spend on bringing players in. This is why they have invested substantial funds into improving the Vitalis Park facility, which now features 11 grass pitches and 7 synthetic pitches. There is a risk that players would then be transferred to richer clubs at a younger age, but the financial arguments are pretty compelling.

"The dynamic duo"

The fact is that the Portuguese League does not generate enough money on its own for its clubs to compete in the upper echelons of the Champions League. Many clubs are struggling financially, over burdened with debt, leading to seven clubs from the top flight recently seeking assistance from the LPFP (Portuguese Football Federation). Although this theoretically represents financial aid to improve sports facilities, it looks more like grants are being given out to enable the survival of these clubs.

This is the situation in which Porto operates, so their focus on making money from selling players is perfectly understandable. They have become the ultimate football traders, buying low and selling high with great success, which should be applauded, especially as their results on the pitch have rarely suffered. It’s a delicate balance, however, as seen by their failure to qualify for this season’s Champions League. This year looks much more encouraging though with a very good possibility that the league title will once again return to the Dragons’ Den.

Spurs Daring To Dream

When Tottenham Hotspur were three-nil down to Young Boys Bern after only 30 minutes of their Champions League qualifying match in August, it looked for all the world as if their European adventure would be over as soon as it had started. With Michael Dawson and Sebastian Bassong doing passable imitations of Bambi on ice, the Swiss minnows were ripping the North Londoners a new one every time they attacked. After many years of waiting for a chance to have a crack at Europe’s elite, the hopes and dreams of the Spurs fans were disintegrating before their eyes on YB’s plastic pitch.

However, Spurs somehow reduced the deficit and predictably crushed their unheralded opponents in the return leg at White Hart Lane to secure their place in the Champions League group stage. Since that nervous start, Spurs have at times played some exhilarating football in Europe’s premier tournament, winning all three of their home games by wide margins, including an unexpected 3-1 demolition of the reigning champions Inter, leading to them already qualifying for the last 16 with a game in hand.

They are also riding high in the Premier League, currently sitting in fifth, just one place outside the qualifying positions for next season’s Champions League, so everything would appear to be rosy in Tottenham’s garden these days.

The news off the pitch also seems very good with the club’s press release for the 2010 financial results highlighting “record revenues of £119.8 million” and “profit from operations excluding football player trading of £22.7 million.” You have to look long and hard before you discover that Tottenham actually reported a pre-tax loss of £6.5 million, a decline of nearly £40 million from last year’s profit before tax of £33.4 million.

Of course, most companies will accentuate the positives in their results, but this is particularly misleading, not to mention absurd if you consider that “football player trading” is almost by definition a core part of a football club’s business, especially as it forms an essential element of the modus operandi at Spurs, and represents real income and expenses. Funnily enough, the 2009 annual report instead opted to focus on the “record profits before tax of £33.4 million”, rather than mention the “profit from operations excluding football player trading”, presumably because that actually fell last year from £27.5 million to £18.4 million. There’s so much spin in these statements that you almost expect to hear an Australian wicket-keeper cry, “Bowled, Warnie”, as the great man delivers another vicious leg-break.

To be fair, there are two ways to interpret these accounts. Taking a negative stance, I would point out that, despite reporting record turnover, the club still made a loss. They might argue that the cash profit (EBITDA) of £25.4 million, comprising the profit from operations excluding player trading of £22.7 million plus £2.8 million depreciation added back, is fairly impressive, but this is still not enough to cover interest payments of £5.0 million and net transfer spend of £27.5 million (£34.5 million of sales less £62.0 million of purchases).

"Tactics? Absolutely delicious"

On the other hand, more positively, almost all of the reduction in profits came from lower player sales with the £15m earned in 2010 (Darren Bent to Sunderland, Didier Zokora to Seville and Kevin-Prince Boateng to Portsmouth) nowhere near as much as 2009’s unprecedented £57 million (Dimitar Berbatov to Manchester United and Robbie Keane to Liverpool). Wages rose £7 million, but this was covered by higher TV money.

In fact, compared to the losses made at other leading clubs recently (Manchester City £121 million, Manchester United £80 million), Spurs’ modest loss of £7 million is quite encouraging, especially as their figures do not include any money from the Champions League. As Roy Kaitcer from stockbrokers Brewin Dolphin said, “The figures look very good. If I was a Spurs fan, I’d be pretty happy.”

That’s why the blatant attempt to “spin” the results is so disappointing, as there’s really no need to do so, with the figures indicating that the club is well run financially, all things considered. This should come as no surprise, given that this year’s loss is the first since 2004. For a club with Champions League aspirations on a relatively low turnover, that’s no mean feat and should be applauded.

Even with this year’s increase in revenue to £120 million, Spurs are still a long way behind the traditional Big Four clubs in England: Manchester United £286 million earn more than twice as much; Arsenal £223 million (football income only) earn over £100 million more; while Chelsea £206 million and Liverpool £185 million also have significantly higher turnover, even though those are last year’s figures. Manchester City have also overtaken Spurs with their revenue rising from £87 million to £125 million.

The problem for Spurs is that even though their revenue has grown at an imposing 69% over the last five years, this has been more than matched by other clubs, who have increased their revenue at an even faster rate. Both Manchester United 72% and, even more emphatically, Arsenal 94%, thanks to the Emirates effect, have outpaced Spurs. The 2010 accounts for Chelsea and Liverpool have not yet been published, so we don’t know their growth rate over the full period, but we can be fairly sure that the revenue gap in absolute terms will not have diminished.

However, Spurs’ 2009 revenue of £113 million was still enough to place them 15th in the Deloittes Money League for European clubs, so it’s not that shabby. To place that into context, it’s not far behind Lyon’s £119 million, which was sufficient to fund a team that reached the Champions League semi-final last season. Moreover, if the £40+ million revenue that Spurs can expect to gain this year, mainly from their run in the Champions League, were to be added to the current revenue of £119 million, they would then have turnover of around £160 million, which would not be too far behind Inter’s £167 million – and they actually won the trophy.

Partly as a result of the lack of Champions League broadcasting income, Spurs’ revenue mix is fairly well balanced, though the increasing influence of Sky TV money is evident, now accounting for 43% of the total turnover. Although this is obviously a key factor, Spurs are still far less reliant on TV income than most clubs in the Premier League, with only the Big Four having a lower percentage and other clubs dangerously dependent on TV with over 70% of their money coming from the Murdoch empire. The other obvious trend for Tottenham is the declining significance of gate receipts, which have fallen from 30% to 23% of the total income, hence the plans for a new stadium.

Media and broadcasting revenue increased this year by 15% (or £7 million) to £52 million, largely due to a higher central distribution of £49 million from the Premier League. This was attributable to a higher merit fee award based on the final league position of fourth compared to eighth the previous season (£4 million increase) and a rise in the facility fee, based on the number of times Spurs featured in live television games (£2 million increase).

The last time TV revenue rose by a similar amount was in 2008 (from £34 million to £40 million), which was as a result of the new Sky contract for 2008-2010. In the same way, the new three-year deal for 2010-13 will also deliver higher revenue to each Premier League club, thanks to the significantly higher money for overseas rights, which could be worth up to £10 million extra for Spurs.

In spite of these riches, Spurs’ TV income in 2010 is still much lower than the other top English clubs, who enjoyed the benefit of additional cash from the Champions League, which in 2009/10 was worth an average of £30 million for the English teams (Manchester United £39 million, Arsenal £28 million, Chelsea £27 million and Liverpool £24 million).

"Best player in the world"

The money that Spurs will receive from UEFA for the Champions League 2010/11 is primarily dependent on how far they progress, though there is also a sizeable chunk linked to the TV (market) pool.

Every team that qualifies for the Group Stage is awarded €3.9 million for participation plus another €550,000 per match played in the group phase, regardless of the result, so that’s a guaranteed €7.2 million. On top of that, there is also a performance bonus of €800,000 for every win and €400,000 for every draw in the group stage. To date, Spurs have won three matches, drawn one and lost one, giving an additional €2.8 million. If we assume that the final away game to Twente Enschede is a draw, that would increase to €3.2 million. Spurs will also pick up €3 million for advancing to the last 16. Even if they were to get eliminated at this stage, they would receive the princely sum of €13.4 million in prize money.

There is additional performance money for each further stage reached, so if Spurs were to hit the ball out of the park (sounds wrong, but you know what I mean), they would receive the following: quarter-final €3.3 million, semi-final €4.2 million, finalists €5.6 million and winners €9 million. So if Spurs went all the way and won the damn thing (miracles can happen), they would earn around €30 million, which is serious money in anybody’s book(s).

"Crouchie's having his nachos"

In addition to these fixed sums, Spurs will receive a share of the television money from the market pool. This is a variable amount, which is allocated depending on a number of factors: (a) the size/value of a country’s TV market, so the amount allocated to teams in England is more than that given to, say, Spain, as English television generates more revenue; (b) the number of representatives from your country, so an English team (with four representatives) might receive less than a German team (with only two representatives); (c) the position of a club in its domestic championship in the previous season, so if two teams from England both reach the quarter-final, the one that finished ahead of the other in the Premier League would get more money; (d) the number of matches played in the current season’s Champions League. This all makes it difficult to estimate but a reasonable figure for Spurs would be around €17 million, based on a small uplift to last year’s figures.

That would give Spurs a total of €30 million TV money from UEFA for the Champions League, which is equivalent to £25 million at current exchange rates. That’s a tidy sum, which on its own would increase Spurs’ turnover by over 20%. Given its potential impact, it’s easy to see why clubs strain every sinew (and spend to their limit and sometimes beyond) to reach the promised land of the Champions League. Of course, there are “only” four places available, so it’s still a gamble, but the size of the prize is striking.

"Razor sharp"

Spurs have received many plaudits for their commercial acumen, but this has not yet been reflected in the financials, as commercial revenue has actually been falling for the last two seasons from £38 million to £34 million. Much of this decrease comes from corporate hospitality, which has suffered both from the economic recession and the club not being in a European competition, though the latter cause should have been addressed this season. Merchandising rose slightly to £8 million this year, but is still below the peak of £10 million in 2008, which was boosted by shirt sales relating to the clubs 125th anniversary and new kit launches.

However, Spurs will benefit from two new shirt sponsors in what they describe as “a ground-breaking innovative split of the shirt sponsorship inventory”, with software company Autonomy becoming the sponsor for all Premier League matches (£10 million a season) and asset manager Investec taking on the sponsorship for all cup competitions (£2.5 million a season). Both agreements run from July 2010 for two years, with the Autonomy deal having an option to extend for a further five years, so will only be reflected in next year’s accounts.

"The only way is up"

The combined £12.5 million is worth £4 million more a season than the £8 million paid by previous sponsors Mansion and is the fourth highest in the Premier League, only behind Manchester United, Liverpool and Chelsea. It’s also a lot higher than the £5.5 million that Emirates pays Arsenal, though that is largely due to the upfront cash payments that were needed to help fund the Emirates construction. Nigel Currie of sponsorship consultancy Brand Rapport has praised the Spurs’ arrangement, “It seems if clubs can cut their sponsorship cloth a different way, they can extend their offer to more than one brand. I think that other clubs may now look at ways of increasing the value of their shirt sponsorship.”

The five-year kit deal with Puma worth a reported £5 million a season has been extended by a further year to run until the end of 2011/12. This is just one of a number of high quality partners, the list also including BT, Thomas Cook, MBNA, Sportingbet and Ladbrokes.

The other revenue stream, gate receipts, has also been decreasing: from £31 million in 2007 to £27 million in 2010, though this is heavily influenced by the number of cup matches. In the 2006/07 season, Spurs had three major cup runs, reaching the quarter-finals in both the FA Cup and UEFA Cup and the semi-finals in the Carling Cup, generating gate receipts of £13 million, compared to £7 million in 2010. This also explains the large jump in gate receipts in 2007, as the previous year included only £100,000 for cup competitions. In other words, qualifying for the Europa League can still be beneficial in terms of match day income (assuming the fans turn up), even though the prize money is considerably less than the Champions League.

"Huge talent"

Underlying gate receipts, i.e. those from league matches, have actually been steadily increasing every year, from £17 million in 2005 to £20 million in 2010, when the stadium was filled to its 36,500 capacity for every Premier League match, despite the season ticket prices being the third highest in the country (though prices were frozen for up to two years in 2009).

In the annual report, the club is keen to emphasise its focus on the cost side of the business. In 2007, it somewhat ostentatiously stated, “Whilst more and more money enters the game, primarily from the central FAPL TV deal, we endeavour to control our significant cost base”, while the 2009 accounts also mentioned “the club’s ongoing and prudent cost control policies.” I have little doubt that Spurs have indeed attempted to control costs, but the fact remains that (including player amortisation) these have grown by £66 million (94%) in the last five years, while revenue has only increased by £49 million (70%). Heaven knows what the cost growth would have looked like if they hadn’t adopted this frugal approach.

Obviously, what has been driving the cost growth, just like any other football club, is player costs, namely wages and amortisation. There is some evidence of the famed Redknapp effect with wages increasing £14 million since his arrival in 2008, but, truth be told, other managers have contributed just as much to the growth with wages also rising £20 million in the previous three season. It appears as if chairman Daniel Levy is keeping the old rogue on a tight leash – a case of an irresistible force meeting an immovable object. That said, Spurs’ salaries did grow by a worrying 11% last season, which is higher than Manchester United’s 7% and Arsenal’s 6%.

This lead to an increase in the important wages to turnover ratio to 56%, but this is still very good and is, in fact, the third best in the Premier League (only behind United and Arsenal), which is a notable achievement given the small turnover. This is because Levy’s negotiating skills have managed to keep the wage bill in check to date. He has refused to compromise the wage structure at Spurs, so in the summer they were unwilling to foot the bill for Joe Cole’s exorbitant wage demands and only took on William Gallas when he lowered his salary.

Moreover, the 2006 annual report intriguingly mentions, “The policy throughout the club is to reward performance based on the continued success of the club”, which raise the possibility that Spurs, unlike many other clubs, have actually got their bonus scheme right, though cynics might point out that there has been precious little success to reward.

I also wonder how much of an impact on the wage bill the decision to withdraw from the Reserve League has had. For example, the 2009 accounts stated that 19 players had gone on loan, which is a policy that clearly reduces the payroll.

Whatever the reasons, Tottenham’s wage bill of £67 million is by some distance the lowest of the “mini league” featuring the Big Four plus Spurs and Manchester City. It’s effectively half the size of Chelsea, City and United; £44 million less than Arsenal; and £23 million below Liverpool. Of course, at the same time, it’s higher than the other teams in the chasing pack like Everton and Aston Villa, leaving Spurs in an uncomfortable “piggy in the middle” position. If they want to consistently match the big boys, the chances are that they will have to push forward and spend more on wages, but they will also need to grow revenue season after season if they are to do that with confidence.

So Levy has done a fine job in keeping wages down, but he is equally adept at negotiating his own remuneration, which has increased from £250,000 in 2004 to £1.35 million in 2010, split evenly between fees and bonus. Similarly, the remuneration of the Finance Director, Matthew Collecott, has increased from £96,000 to £504,000 in the same period. All told, these two directors have received £5.5 million and £2.1 million respectively in the last seven years. In fairness, these are not outrageous sums when compared to the figures earned by their peers at the Big Four, though some might argue that they are bigger clubs (larger turnover, more success, higher profile), so there should be a premium.

There has also been a steep increase in player amortisation, namely the annual expense of writing down the purchase price of new players, which has more than tripled since 2005, rising from £13 million to £40 million. That’s a lot (it’s the same as Manchester United), though it’s still on the low side compared to clubs known for being big spenders in the transfer market: Manchester City £71 million, Chelsea £49 million.

The concept of amortisation confuses many people, but it is simply how accountants handle player transfers. Instead of booking 100% of the player’s transfer price as a cost in the year of purchase, accountants treat players as assets, so the cost is capitalised and written-down (amortised) over the length of his contract. At the end of the contract, he is considered to have no value, because he can then leave the club on a free transfer.

It’s probably easier to understand with the recent example of Rafael van der Vaart. Spurs bought the Dutch maestro for £8 million, so if we assume that his contract is for four years, then the annual amortisation is £2 million. After three years his net book value in the accounts will be £2 million (the original cost of £8 million less three years amortisation at £2 million per annum).

Spurs’ ever-rising amortisation therefore suggests that they are big spenders in the transfer market and that is indeed the case. The last time that Spurs had a net surplus on their transfer spend was ten years ago in 2000/01, while since then they have been the very definition of a buying club, leading to an aggregate net spend of almost £150 million in the decade (£320 million purchases less £170 million sales).

To place that into context, only Manchester City, fuelled by the Sheikh’s billions, have spent more than Tottenham in the last five years. With a net £91 million, Spurs have spent twice as much as Liverpool, four times as much as Chelsea, nine times as much as United, while Arsenal have actually generated a surplus from their transfer activities. In fairness, the frequent changes of manager (Martin Jol, Juande Ramos, Harry Redknapp) have made a high level of player turnover inevitable, leading to what the chairman described as “one of the largest squads in the Premier League.”

Levy would argue that the investment in the first team squad has been worthwhile in that it has meant qualification for the Champions League, which is clearly a valid point, though the impact on the club’s financials is not so palatable. Remember that this year the club made a profit before player trading of £22.7 million, but this became a £6.5 million loss after the impact of splashing the cash in the transfer market was taken into consideration. And there’s little sign of this abating, as the squad was “boosted” after the year-end with yet another £20 million of purchases, including van der Vaart, Gallas, Sandro and Stipe Pletikosa.

To be fair, the high level of player purchases has not put the club into debt. Yes, the club holds net debt of £64 million (excluding CRPS liabilities), but the vast majority of that is property specific. In 2006 the club was actually in a net cash position to the tune of £24 million, but since then the debt has been rising year after year: 2007 £2 million, 2008 £15 million, 2009 £46 million and 2010 £64 million. If the liability component of the Convertible Redeemable Preference Shares were classified as debt (as the accounts do in the analysis of Total Borrowings), then the net debt could be considered as £79 million.

The debt comprises £50 million of bank loans, including a £15 million short-term revolving loan from HSBC and a £33 million facility with the Bank of Scotland at a floating rate linked to LIBOR; plus £25 million of loan notes at an interest rate of 7.29% repayable in equal instalments by September 2023; less £11 million of cash. All the loans are secured on club assets.

Even though debt has been increasing, total liabilities actually fell £11 million to £218 million last year, largely due to a decrease in trade payables. In fact, the balance sheet is quite strong with net assets of £71 million, including tangible assets of £124 million, comprising White Hart Lane £39 million, new stadium project £72 million and the new training ground at Bulls Cross in Enfield £12 million, and intangible assets (players) of £116 million. Of course, the market value of the players in the real world is far higher than the carrying value in the accounts. Transfermarkt estimates a value of £258 million, but even that is under-stated, as they only ascribe an £18 million value to Gareth Bale, who is, of course, the eighth wonder of the world.

However, as the accounts say, “This huge investment over the years has been funded through equity contributions and long-term debt financing.” Although the club generates cash from its operating activities (£20 million in 2010), once it has made interest payments and invested in capital expenditure (players and property), it has a net cash outflow (£33 million in 2010). This has only been (partially) compensated by additional funding, which last year came via a combination of £10 million more debt and £15 million of new share capital. In fact, in the last four years, some £70 million of additional financing has been required to maintain the cash outflows at a manageable level.

This trend is likely to increase in the future, as Spurs will have to invest a great deal of money in the planned new 56,000 stadium. As Levy explained in a statement on the club’s website, “It is indisputable that we now need an increased capacity stadium in order to continue to move the club forward and compete at the highest levels.” White Hart Lane may be an atmospheric stadium, but its 36,500 capacity cannot provide the £100 million match day revenue enjoyed by clubs like Manchester United and Arsenal. To give a fair comparison, some corporate hospitality should be added to Spurs’ gate receipts of £27 million, but their revenue would only be around £40 million (per Deloittes Money League), which is still £60 million lower. Spurs’ enthusiasm for the project is even more understandable with 33,000 supporters on the (paid-for) season ticket waiting list.

The search for a new stadium has effectively come down to two viable options: (a) the Northumberland Development Project in the area around White Hart Lane; (b) relocation to the Olympic Stadium in Stratford. Up until a few months ago, it seemed that the NDP was the only game in town (2009 accounts: “as a club, we are proud of our roots in Haringey”), but there is now a distinct possibility that Spurs will move away from their spiritual home. Although the plans have now been approved by both the local council and the Mayor of London, revisions have added £50 million of costs, bringing the total budget required to an eye-watering £450 million.

In order to minimise the club’s exposure to debt, it hopes to subsidise the project costs with supporting developments, such as new homes, hotel and supermarket, and sell naming rights for the stadium. According to an article in the Daily Mail, the new commercial director, Charlie Wijeratna, has been tasked with securing an astonishing £300 million over 20 years for naming rights, which would go a long way towards solving the funding issues (though there may be some implications for shirt sponsorship). However, Levy has confirmed that additional financing would still be required, either through issuing new shares in the club or bank loans, which would not be cheap (Manchester United’s bond is 8.75%, while Arsenal’s is 5.75%).

"Grounds for optimism"

As well as the high cost, there are other issues with this project, namely the total lack of public money being made available for regeneration (in contrast to the stadium developments at Wembley and Arsenal) and the chronically poor transport infrastructure, so it is only prudent to consider other alternatives. However, if Spurs were to abandon the White Hart Lane solution, they would face some other financial issues. First, they would have to write-off the £20 million of planning and professional fees currently held on the balance sheet. Second, they would have to sell the £50 million of property that they have already purchased, which may prove difficult, as this is by no means prime real estate, though the accounts do state that they have gained “the critical mass to achieve a substantial site sale as a contribution to a relocation.”

Hence, the decision to keep the club’s options open by registering its interest in the Olympic Stadium site (along with AEG). Estimates of the costs required to convert this into a football stadium vary, ranging from £100 million to £200 million, but there’s no doubt that this would be a significantly cheaper opportunity, especially as there is apparently £35 million available in the Olympic legacy fund to help finance the conversion. Some of the costs would also be recouped by Tottenham selling their property around White Hart Lane.

"Appy 'Arry"

Many regard Spurs’ interest in the Olympic Stadium as simply a negotiating tactic, an act of brinkmanship designed to persuade Haringey council to contribute money towards the cost of the Northumberland Development, but Tottenham director Sir Keith Mills insists that the club is serious, “If the Olympic Park Legacy Company decides our bid is the preferred one, then we’ll put all our efforts behind trying to move there.” Indeed, Levy has pointed out that the Olympic site is only five miles from the current stadium with excellent transport links.

Obviously, the majority of Tottenham fans are nervous about this prospect, including local MP David Lammy, who complained, “Levy is willing to sacrifice the atmosphere of White Hart Lane to stuff the Olympic Stadium with corporate hospitality boxes. Tottenham Hotspur should be a club for everyone, not just the suits in the City.” That’s a bit harsh, given that the chairman has a responsibility to the financial stability of the club, but essentially that’s what the argument boils down to: history and tradition against financial benefits.

Of course, it may not be up to Spurs, as West Ham are still considered the favourites for the Olympic Stadium, not only because they are the local club, backed by Newham council, but they have also promised to retain the running track to preserve the commitment made as part of the London 2012 bid. That said, the authorities now seem relaxed over the idea of providing upgraded athletics facilities elsewhere, e.g. Crystal Palace. Furthermore, Spurs’ plan could be more commercially viable, especially if the Hammers are relegated.

Ironically, if and when these plans come to pass, Spurs’ business model would then closely resemble that of Arsenal, as they seek to emulate their fierce rivals’ success off the pitch as well as on it. At the moment, the finances are very different with Arsenal’s profits being £50 million higher: their revenue is £100 million higher, but Spurs’ expenses are £70 million lower. Arsenal also make more money from player sales, but pay more in interest for construction loans. However, in the future, you could envisage a scenario where the additional gate receipts from a new stadium would boost Spurs’ revenue, allowing them to loosen their tight wage structure, when the two clubs would be much more similar.

In the short-term, Tottenham’s revenue next season should already increase by around £45 million, comprising £10 million from the new Premier League TV contract, £30 million from the Champions League UEFA central distributions, £4 million from the new shirt sponsorship deal and £6 million gate receipts (4 Champions League matches at £1.5 million, though this depends on other cup matches). However, this extra money will not all go to the bottom line, as the wage bill and player amortisation will increase for new players, while there will be expenses for hosting European matches. That could easily add up to £20 million, but this would still leave a clear £25 million improvement.

"My name is Luka"

It therefore appears as if Spurs will be well placed to meet the impending UEFA Financial Fair Play Regulations. Indeed, the club’s finance director believes that these will “vindicate” their financial prudence, while also supporting their decision to go for a new stadium, as it is “now more important to drive revenues to the next level.” Given that the new rules are all about clubs operating within their means, it clearly makes sense to boost Spurs’ revenue in this way, especially as the stadium development costs are excluded from the break-even calculation.

However, they will still have the major challenge of consistently qualifying for the Champions League. Daniel Levy has insisted that he will not jeopardise the club’s finances by chasing qualification every year, but it’s a delicate balancing act. If they don’t succeed, potentially Spurs could end up with a squad being paid Champions League wages without the revenue to compensate. That would then present them with the eternal dilemma: would they be tempted to spend more money to win their place back? Or would they balance the books by selling players, which would make it more difficult to qualify?

That is why so much rests on the money from a new stadium, which would give them more room to manoeuvre financially and help create a virtuous circle: higher revenue, better players, regular Champions League qualification. Of course, building a new stadium is far from a straightforward task and the club will almost certainly end up with a lot of debt to service, which may well compromise their ability to invest in the first team squad, which has been the cornerstone of their recent strategy. There is also no guarantee that the crowds will turn up, even with that lengthy waiting list for season tickets.

"Daniel Levy - one smart cookie"

Spurs are in pretty good condition at the moment. The core business is clearly very healthy, for which the chairman Daniel Levy deserves a lot of credit, especially as he has one of the most spendthrift football managers around in Harry Redknapp. However, it feels as if the club is standing at a crossroads financially as they are confronted by some critically important investment decisions.

The club’s motto is famously, “To dare is to do”, but do they simply dare to remember? After all, the annual report concludes with a reminder that next year is the 50th anniversary of the last time Spurs won the league. Or will they risk a lot of money and dare to dream?