The last time I wrote about Heart of Midlothian back in
January 2016, the club had recovered from some troubling times, was
back in the Scottish Premier League and in a financially solid state. Ann Budge
had succesfully steered the ship to calmer waters, and all looked well and
positive for the club. I ended that blog post by saying ”Heart of Midlothian
seem to be in good hands again”. After close to two years later, that still
seems to be the case. Even if the current position in the league table (5th)
may not be quite what fans had hoped, the club is nevertheless in a solid
state, and Budge has taken the club forward determinantly and in a stable
manner.
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| Tynecastle Stadium, image was originally posted to Flickr by zh1yong at http://flickr.com/photos/68026101@N00/386235153 |
After winning the Championship in 2015,
Hearts returned to Premier League. And some return that was; Hearts placed 3rd
in their first season back in the top flight, made it to the QF´s of the League
Cup, and thanks to that 3rd place in Premier League, earned a spot in the next
season´s Europa League. If things were
progressing well on the pitch, Budge was also making sure the club wasn´t
standing still off it, either. In May 2016, Budge revealed the £ 12 million
redevelopment plan for a new main stand
housing 7 000 spectators, which would increase Tynecastle´s total capacity up
to 21 000. At the time Budge said that redeveloping the stand was not part of
the original plan she had for Hearts. As she told Daily Mail; ”Redeveloping the stadium was absolutely not part of that
five-year plan. However, circumstances, performance and reaction from
supporters have all been such that it became fairly clear that, if we could, we
would accelerate the redevelopment plan”. Budge also stated that at
the time half of the funding was already in place, and that the club intended
to go through the process without raising bank debt. The goal was for the main
stand to be completely paid off by the time it would open. The project has been
anything but simple. The club has been forced to relocate offices to temporary
location, as the old office spaces, club store and ticket-office building had
to be demolished, so that the construction of the new main stand could begin.
And obviously the old main stand had to be destroyed as well.
The effects
of the construction process are easy to see in the club´s balance sheet, as the
amount of tangible assets has rocketed from £ 6,9 million in 2015 all the way
to £ 13,4 million in 2017.
Of the
total amount in 2017, £ 5,1 million was ”land and buildings freehold”, and £
5,5 million ”assets in the course of construction”. This obviously refers to
the construction of the new main stand, which was an ongoing process by the
time of the accounts. As the strategic report of the accounts states; ”At 30 June 2017, approximately £ 6
million of the stadium redevelopment costs had been capitalised”. Just to
be clear, when something is capitalised to the balance sheet, it means it is
recorded as an asset, and not as an expense in the profit & loss account. Usually
when you capitalise something, it should have some future value to the company.
Many start up –companies, for example, capitalise their research & development
costs to the balance sheet, rather than present them in the profit & loss
account, as there is usually very little turnover, but lots of costs. But the
basic idea is that those R&D costs should eventually lead to a finished
product that will start to accumulate revenues later on.
As
Budge said, the project was to be done without raising bank debt. Looking at
the balance sheet, that is indeed the case, and the solidity of the company has
actually improved, despite the large investments.
The
first thing you see when looking at the balance sheet, is that the equity of
the club has gone from £ 1,3 million to £ 11,5 million in just two years. How
is that possible? Normally one would assume that the company in question has
had a profitable couple of years, recording nice profits that increase the
total amont of equity, which can then be paid out in dividends. But in the case
of a football club, this seems a bit far fetched.
The
club has actually recorded positive profits over the last two seasons, as is
indicated by the improving profit & loss –account figure. But this hasn´t
really been the result of profitable operations as such, but rather due to one
off –items the club has received in the last two years. During the season
2015/2016, Hearts sold forward Osman Sow to a Chinese club Henan Jianye, and
recorded a profit of £ 1 milion, which turned the result of the year positive.
In 2016/2017 season, Hearts received an ”exceptional donation of £ 2,5 million
towards the cost of the Tynecastle redevelopment project”, as it was stated in
the accounts of 2017. That obviously did wonders for the result.
But
the most significant item in the club´s equity is the ”other reserves”, which
has gone from £ 0 in 2015 to £ 5,7 million in 2017. This is the amount that the
club has received from the Foundation of Hearts. Originally it was classified
as a liability (£ 2,7 million in 2015). In the accounts of 2016, the approach
was changed. As stated in the accounts of 2016 ”These funds are not repayable to Foundation of Hearts Limited and
therefore have been reclassified as equity rather than as a liability.” As
the club received £ 1,5 million from the Foundation of Hearts, the total amount
was therefore £ 4,2 million in 2016, and increased to £ 5,7 million in 2017.
This allows the club´s equity to improve every year, as long as the annual
donation from the Foundation of Hearts exceeds any possible losses the club
records. The equity ratio (equity/total balance sheet *100) was at 53,7 % in
the latest accounts, which is a very high figure for a football club, and a
healthy level for any limited company.
On the
liabilites side of the balance sheet, the situation has improved as well, as
the loan from the Foundation of Hearts has been moved to equity. The net debt has
therefore declined as well, and has been negative for the past two years since
cash balances have been at a very healthy level. The
club´s only actual loan is now the £ 2,3 million owed to group undertakings,
Ann Budge´s Bidco (1874) Limited. The reason this amount has slightly declined
in 2017 is not due to any kind of repayment of the loan. As the club states in
the latest accounts; From 1 July 2016
until 31 May 2018, Bidco (1874) Limited has granted an interest holiday on its
loan of £ 2,4 million to the company. Therefore, in line with the accounting
policy set out at note 1.9, the loan has been accounted for within these
financial statements as a financing transaction at the present value of future
payments discounted at a market rate of interest. No repayments of the £ 2,4
million have been made by the company to Bidco (1874) Limited.” To sum it
up, Hearts´ balance sheet is at an unusually healthy level for a football club.
And the funds from the Foundation of Hearts keep improving it.
The
cash flow of Hearts is also very telling of Hearts´ operations in the last few
seasons. In 2015 and 2017, the club has managed to create a notable level of
operating income. Although it should be noted that in both cases this was a
result of favorable movements of working capital items. Operating cash flow
consists of the amount made from actual operations (EBITDA, or Earnings Before
Interests, Taxation, Depreciations and Amortisations), and changes in working
capital. Working capital items are usually inventory, short term payables and
receivables. If a company´s receivables decline, it is a positive change in
operating cash flow, and vice versa. The same applies for payables; if the
amount of payables increases, it has a positive effect on the cash flow. In
Hearts´ case, deferred income (registered in liabilities) increased by £ 1,7
million in 2015, improving the operating cash flow. In 2017, debtors decreased by £ 1,0 million.
A very
telling item in the cash flow is the ”net capex” . This figure represents the
total capital expenditure (i.e. investments and divestments) that the club has
made. In 2015 this was a very small
figure, only £ 0,2 million. The club used a minor £ 145 000 to player
acquisitions, but that was pretty much all capex the club made that year. The
following year Hearts´ capex was actually negative, meaning the club divested
more assets than it acquired. This was due to the sale of forward Osman Sow.
The transfer sum was reportedly £ 1,73 million (source: Transfermarkt), of
which the club received a little over £ 1 million in 2015/2016. This is a good
example of what kind of an impact a sale like this has for a Scottish Premier
League club.
Last
season, the club did spend £ 454 000 on player acquisitions, but by far the
majority of capex (£ 4,8 million) was used on purchase of tangible assets,
which is obviously the construction of the main stand at Tynecastle. The club
also received £ 384 000 from player sales, which brings the total capex to £
4,9 million. The full capital expenditure is presented in the figure below:
An
important part of the financing of Hearts is the funds the club receives from
the Foundation of Hearts, this item has been £ 1,5 million in the last three
years. This is a vital part of Hearts´operations, as an annual £ 1,5 million
item is something that really allows the club to invest, whether to the squad
of the facilities, without having to withdraw loans. There is a five year –plan
in course for the Foundation, as it says at their own website; ”The Foundation has signed up to providing £
1,4 million in year 1, and £ 1,4 million in year 2. Monies raised over and
above this will be accrued over the next years to repay the loan provided by
Ann Budge of £ 2,5 million; the loan that effectively saved the club. This
means that the total that the Foundation will require to raise in the five
years since its inception will be £ 6,3 million.”
The
goal of the Foundation is to eventually take over the ownership of the club, and
operate a healthy going concern. The funds are collected from ~8000 members,
who contribute financially to the Foundation. The Foundation then provides the
funds to Hearts. This is really an admirable sign of commitment from a large
group of fans. As the funds distributed to Hearts are not loans, there is no
real return on the money. And it´s hard to see the club paying out dividends
after the Foundation takes over the ownership, so it really is donations that
the fans are paying. For most of them, being there to help save their favorite
club and take it forward is more than enough reward. If that´s not a sign of a
true fan, I don´t know what is.
On top
of donations from the Foundation, another significant item in last season´s
cash flow is the ”funds from exceptional donation”, worth £ 2,5 million. The
money was used for construction of the new main stand. While the indentity of
the source is unknown, it certainly has helped Hearts immensely in the
construction project. As Daily Record reported last November, Ann Budge has
stated that the project was expected to go over budget, as these kind of
projects more often than not do. Hearts have also secured a bank loan of £ 1,75
million that can be used, if needed.
If the
club´s cash flow is strongly reliant on the annual donations from the
Foundation, the club´s profit & loss account is in a healthy state, as
well. To be clear, the funds received from the Foundation of Hearts are part of
the club´s cash flow and balance sheet, but not the profit & loss account.
Turnover
has increased in the past three years. The increase from £ 7,0 million in 2015
to £ 10,0 million in 2016 is obviously the result of the club´s return to
Premier League for the season 2015-2016, and placing 3rd. This led to increase
in SPFL monies, increase in ticket income (the club sold over 13 000 season
tickets), increase in commercial activity andincrease in sponsorship and advertising
activities. According to the accounts of 2015-2016, the club also brought the
retail operations inhouse, which led to a new retail revenue stream. Overall, a
30 % increase in turnover is quite a leap.
The
next season, revenues kept on increasing, even though the club´s position in
the league table dropped to 5th. This was likely affected by the departure of
head coach Robbie Neilson, who left in December 2016 after receiving a tempting
offer from MK Dons. Neilson was an important figure in the club´s surge to the
Championship title, and likely would have had a good future at Tynecastle as
well. In the end, the challenge provided by MK Dons was just too much to
resist, and you can´t really fault an ambitious young manager for that. But it
certainly affected Hearts´season.
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| Robbie Neilson, This image was originally posted to Flickr by www.theedinburghblog.co.uk at http://flickr.com/photos/15441925@N00/146267325 |
Despite
this setback, once again more season tickets were sold (13 700), home matches
were mostly sold out, and retail operations also kept increasing. The turnover distribution
in presented in the figure below:
While
turnover increased, Hearts´ average atendance actually declined slightly last
season, but not by much. Looking at the average attendance between 2012 and
2016, the trend has been increasing in the last few years, but the numbers also
show the loyalty of the fan base, as even in struggling times the average
remained at over 13 000.
Looking
at the average attendances of the whole Premier League, Hearts was in 3rd place
last season, obvioulsy well behind Celtic and Rangers, but above Aberdeen, for
example. Not bad at all, but actually the figure above is most telling in the
way that it shows just how much the two Glasgow clubs are ahead of everyone
else.
The
most important cost item for any football club is the wage bill, which
obviously consists mainly of the players´ wages. This is also where many clubs
go overboard, wage bills are often at an unsustainable level, as the clubs
deperately chase promotion to more lucrative leagues. With Hearts, the wage
bill has been very controlled. It has obviously increased as the club has moved
from the Championship to the Premier League, but the spending hasn´t been
reckless.
The
ratio of turnover/wages has been a very steady one in Hearts´ case at slightly
over 50 %, which is a modest ratio for a football club. In the strategic report
of the accounts of 2016, it is actually mentioned that ” the club continues to use a variety of performance measures in order to
monitor and manage the business effectively, with the key performance indicator
being the relationship of payroll costs to turnover”. That is a very
healthy approach indeed, because the operating result obviously is the backbone
of any company; if the operating profitability is weak, the cash flow needs to
be supplemented usually with loans and equity injections from the owners etc.
If the company then wants to invest, it naturally needs even more financing,
which is diffcult to obtain (from banks, anyway), if the operating
profitability is at a weak level, let alone negative.
In
Hearts´ case, the EBITDA has been positive for the past two years. Operating
profit has been slightly negative, but this is affected by amortisations and
depreciations of the club´s assets, which are accounting items that do not
affect the actual cash flow. With the EBITDA positive, there is no need to use
the funds from the Foundation of Hearts to cover losses, instead they can be used
on the development of the operations. Like building a new main stand, for
example. This is clearly what Budge has had in mind: with sustainable cost
structure, funds from the Foundation of Hearts can be used to develop the club
further, and not to cover operating losses. To be honest, if that was the case,
it is likely that not many fans would want to keep donating their money for a
long period of time, either.
Total
profit has been clearly positive for the past two years. As mentioned earlier,
in 2016 the club sold forward Osman Sow, and the club recorded a profit of
£ 1,0 million from player sales. In 2017, the mystery donation of £ 2,5
million (exceptional donation in the accounts), was vital in recording a total
profit of £ 2,3 million.
It is
nice to see club in such a healthy state, with steady funding, new main stand
on the way, and sustainable operations providing the backbone. Budge has done a
tremendous job, and while she has already been the savor of the club, she
clearly has every intention to develop the club even further before
withdrawing, when the Foundation of Hearts takes over the ownership. While the
club will not have the financial resources to really challenge Celtic or
Rangers, it is firmly on its way to being a top 5 club with a solid background
and a positive atmosphere. And as the recent 4-0 home win over Celtic shows,
anything is possible on any given day at Tynecastle.
Budge´s
eventual withdrawal will be something of a test for the club. As the FIundation
of Hearts takes over the operations, there will be some issues that need to be
resolved quickly, mainly relating to the governance and management of the club.
How (and how quickly) the club organises the day-to-day operations and comes up
with a proficient management team that will take over the responsibilities,
will have a big impact on the sustainability of the operations and the
long-term planning. But given the way the planning and budgeting has been taken
care of until now, it would be surprising if these issues hadn´t been
considered already. With a healthy club
and a committed (and generous) fan base, Hearts certainly have plenty to look
forward to.
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| Gorgie Stand, original photo by Alonstoter |
