With the FIFA World Cup in Qatar in full flow, I have had soccer on my mind even when thinking about investing. The big sponsors like Coca-Cola (KO, Financial), Visa (V, Financial) and McDonald’s (MCD, Financial) are front and center as well. However, when the news came through that soccer superstar and the most followed person on Instagram Cristiano Ronaldo was going to leave Manchester United PLC (MANU, Financial) by mutual consent, I was once again reminded of a long-held conviction of mine: that trophy assets like sports clubs and soccer clubs in particular are terrible investments because of the unique and competitive disadvantages facing these businesses.
It's tough when for-profits compete with non-profits
Interestingly, although it was probably the case that Ronaldo was going to be leaving Manchester United after his very controversial interview with celebrity journalist Piers Morgan was released last week, when the news was confirmed the stock price of Manchester United jumped several points. On one hand, this makes sense because Manchester United will be saving a huge amount of money on the wages they will have to pay Ronaldo. On the other hand, it shows the flaws of the soccer business model.
In soccer, the assets of the business are the players. When they are bought, their transfer value is put on the balance sheet and their value amortizes over time. It is difficult to trade players because, like financial options, a player’s value will decrease as their contract runs down. Once their contract has finished, they are free to leave and join another club. Also, to attract the best players, clubs like Manchester United, which are listed on the stock exchange, have to complete with privately owned clubs, often owned by sovereign wealth funds or billionaires who are buying soccer clubs for ego, sports-washing, or a combination of both. Hence the term trophy assets. These private entities are essentially loss-making, financed by wealthy benefactors who want to purchase the best players. Numerous studies show the extremely high correlation between player wages and success on the field. Essentially, teams like Manchester City, or Paris Saint Germain, with near infinite funding, are able to purchase success.
An unusual customer base
Additionally, soccer clubs do not have normal customers. As an individual customer of, say, Coca-Cola, I don’t particularly care about the company's capital expenditures. As long as the product is reasonably priced and does what it says it’s going to do, I will be a happy or at worst neutral customer. In fact, I probably want Coca-Cola to make a profit, so that it doesn't go out of business and I can continue buying its beverages.
But in the world of soccer, where the customers are fans, this logic is almost back to front. Fans demand that owners spend more and more money on players (wages and transfer fees) and associated costs such as training facilities and anything that will attract the best players to their club. Fans measure success by trophies and performance on the pitch and not by financial performance. They don't care that a soccer team is a normal business that needs to make a profit to be sustainable.
The Ronaldo issue
Back to Manchester United, to prevent Ronaldo from joining arch-rival Manchester City in 2021, which is owned by the Abu Dhabi royal family (meaning essentially the Emirate of Abu Dhabi, with all its oil wealth), Manchester United had to pay Ronaldo a king’s ransom to join the club. You could argue this made sense given the boost in performance this would give the team, and the merchandising boost it would give the club, given Ronaldo’s star status.
But soccer players are human beings too, and when Ronaldo had the misfortune of a disaster in his personal life that affected his ability to commit to pre-season training this summer, his new manager decided to not play him very much at all. You could argue this is for sporting reasons or for egotistical reasons. There are always office politics in any business of course. Ronaldo, who has his own personal motivations, felt disrespected, and decided to air his grievances on national television in an interview that every soccer fan has probably by now watched. His frustration and attack on his manager were clear, and ultimately Manchester United decided it best to part ways with the star.
Why trophy assets don't work as investments
This highlights two points. One, that when a small number of human beings are your most valuable assets, you are really carrying a lot of idiosyncratic risk. We will probably never know the exact reasons Ronaldo and his until recently new manager did not see eye to eye, but the fall out has lost Manchester United a brilliant player and hurt the club’s reputation as a top club. Ronaldo claimed in his interview that Manchester United had not invested in the necessary technology and infrastructure needed to keep the club competitive in sporting terms with its rival teams. This is because Manchester United is trying to run itself in a way that balances costs while keeping enough money available to buy players. It is an impossible contradiction.
Soccer clubs in Europe have extremely high compensation to revenue ratios, often close to 100%, meaning profitability is near impossible. Every percentage point in margin investors get, is a percentage point not going on players and I’ve already noted the correlation between player spend and performance on the pitch. This is similar to investment banks, who spend heavily on compensation, but the difference is most investment banks are public companies and stock compensation makes up a large part of employee compensation, but investment banks are usually not reliance on a handful of star employees to drive performance of the whole franchise. Also, we don’t see state-owned investment banks outcompeting publicly held investment banks.
This is why I was very surprised to see one of the U.K.’s top fund managers, Nick Train, who has a better track record in the last 20 years than Warren Buffett (Trades, Portfolio), owning Manchester United. According to Morningstar (MORN), he is hoping that the Glazer family, who owns the majority of Manchester United, will bow to the fan pressure to sell the club to richer benefactors and let Manchester United get taken over, which would likely put a short-term takeover premium on the stock.
Manchester United has a GuruFocus financial strength rating of 3 out of 10, a low Piotroski F-Score of 3 out of 9 and a distressed Altman Z-Score of 0.75. This is because Manchester United was a leveraged buyout in the first place, and Manchester United’s spending on wages and transfer fees has not allowed it to produce enough retained earnings to strengthen the balance sheet.
By all means, own shares of a soccer club if it makes you happy. But as a holding in a portfolio which you are trying to achieve the highest risk adjusted returns, the soccer industry fails in all of Porter’s Five Forces to be competitive. In short, the industry has terrible economics and should be avoided at all costs in my opinion. If your fund manager is owning Manchester United or other listed sports teams, ask yourself why.
