Season 2011-12 Fan Articles

Black Wednesday - A view from The City

My take on the financial reasons behind what we've seen this summer and the events leading up to yesterday (31 Aug 2011 deadline day). Plus an alternative look at the motivation for reducing the debt.

First off, all of the numbers I'm quoting here are taken from the 31 May 2010 accounts (the latest we've got) so they're already out of date but I think it's enough to tell us what we need to know.

The good debt

Everton's debt is £47.6m but this doesn't tell the whole story. What's important when you're looking at debt is how much it costs, when it becomes due, not only interest repayments but if a capital refinancing is needed eg, in the case of a bond which has a 'bullet' payment at the end.

£25.6m of Everton's debt relates to the securitisation in 2002. This is repayable over 25 years at £2.8m a year (capital and interest) so the debt will amortise down to £nil in 2027. It has a fixed interest rate of 7.8% which means repayment amounts are known (as opposed to being exposed to interest rate rises) and with UK 10 yr gilts at 3.75% (the amount the UK borrows at) you'd have to say this isn't a bad deal.

In short, this debt is secure and serviceable. This leaves £22m of other debt, and this is where it gets a bit messy.

The bad debt

Next is a CFO's worst nightmare, a spiralling overdraft (£3.9m in FY09 vs £5.1m in FY10).

Overdrafts are essential for businesses such as Everton with a high amount of fixed regular costs (wages) and largely seasonal variable cash inflows (broadcasting and ticket revenue). However, they are dangerous because they're repayable on demand, meaning the bank could ask for its money back at any point.

Current trends would suggest that the bank may be asking Everton to reduce it's exposure to this kind of debt.

The ugly debt

£17m of total debt is a 'bank loan' which is secured against Goodison Park and broadcast revenues. Most importantly, some of it matures NOW and up to May 2013 meaning that it would need to be repaid in full at this date OR be refinanced ie, borrow £17m from somewhere else and use it to pay off the bank OR extend the facility with the bank (called 'rolling' your financing and highly unlikely in this climate).

The above presents a huge risk to Everton since they need to prove they can meet their obligation up to 2013 otherwise the bank could pull the plug. In my view, this is the reason for some of the asset sales we've seen (Bellefield) and the now infamous 'mortgage no.48' we saw registered at Companies House earlier in the summer. It proves that Everton can arrange a refi on the existing debt if required.

The uglier (hidden) debt

It's my understanding that we pay £1.1m a year for leasing Finch Farm. This obligation does not appear on our balance sheet ('off balance sheet finance'). As a general guide, banks hate this kind of deal because it ties up cash flow and also takes further assets as security ie, the asset being leased (which they can't take for themselves).

A banker would effectively apply an interest rate to the annual charge and come up with a theoretical debt number that would be on Everton's balance sheet if it were not for those troublesome accountants and their rules.

In Everton's case, applying 7% interest (my guess at Everton's cost of borrowing) would suggest an effective debt balance of £15.7m in relation to Finch Farm.

How does Everton pay for this (or not as the case may be)?

Stop reading here if you're of a nervous disposition.

When considering your financing options, the key thing to consider is how much cash you've got to play with in order to meet debt demands. And this is the key for Everton.

Everton's cash that they make from normal business or earnings before interest, tax, depreciation and amortisation (EBITDA ? not including player sales/purchases) in 2009 was £8.1m. Quite healthy but not great when you consider that interest is paid out of this (about £4-5m a year) and any residual would be the transfer budget.

Over stretching

The problems come in 2010 when EBITDA dropped to <£1m. The main driver of this is was an increase in wages of £5.3m and most likely Everton's undoing (wages to turnover now being at 68.7%). ie, at this point (31 May 2010), Everton need to either raise cash from selling assets (Bellefield and/or players) in order to reduce/pay debt. This is most likely in conjunction with a cost reduction exercise (reducing wages) in order to free up more cash to meet debt needs.

In my opinion, this is what we've seen over the last 18 months and came to a head yesterday. Everton have now sold Bellefield, Pienaar, Yak, Beckford and Arteta to help meet bank obligations and has effectively reduced operating expenses by (guess) £9m+ a year, not including wage increases for other players.

In conclusion, the warning signs have been there that this sort of event was likely to happen. However, as fans, we can take comfort that Everton's financial position is not perilous (it's not great, I admit, and not conducive to building a successful team) but suggestions of melt-down or administration are wide of the mark. There are a lot of 'levers to pull' in the event that further repayments are required.

Why else repay debt now?

There have been a few wild internet rumours of late regarding a potential takeover. Whilst none of these seem to have any substance, it's interesting to note the effect that debt has on the amount that shareholders receive for their shares in the event of sale.

Typically, in the sale of a private company, debt is knocked off the business's enterprise value (EV) in order to arrive at purchase consideration (cash that shareholders get). EV is estimated based on the amount of cash a business generates and is expected to generate in the future.

You could argue that a decent way to maximise shareholder value prior to a takeover would be to sell off some 'non-core' assets (they won't reduce EV too much ? in fact they might increase it if you include the wage reduction!), use the cash proceeds to reduce debt, and effectively pocket some extra cash when you sell up.

Food for thought and certainly enough to keep the conspiracists happy.

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