When Will Chelsea Reach Their Target?

While Chelsea continue to battle Manchester United for the Premier League title that apparently nobody wants to win this season, the club's accounts for the twelve months to June 2009 were submitted to Companies House last week. Not a thrilling read, you might think, and you would be right, but two key points emerged in the detailed notes: first, Chelsea’s wage bill was the highest ever reported by a British football club; second, the players earning these salaries are, in fact, worth a lot less than the year before.

This once again called into question whether Chelsea would ever achieve their frequently stated target of breaking even on their financials. Fans with a good memory will remember that this was part of former chief executive Peter Kenyon’s five-year plan, but even his initial confidence appeared to weaken along the journey, “The 2010 break-even is ambitious. I don’t think it’s something we are postponing, but it’s always been ambitious. We are determined to meet it or get as close as we can.” Of course, this has not overly mattered at Chelsea, given the generosity of their wealthy owner, Roman Abramovich, but it could become a more pressing issue, as the Russian has supposedly started to clamp down on the club’s largesse.

"Man with a plan"

Current chief executive, Ron Gourlay, reiterated the target, though quietly dropped the previous deadline, “It is still our aim to be self-sufficient and we will achieve this by increasing our revenues as we continue to leverage off our brand. We are reducing our costs by controlling expenses, including salaries and wages.” Nothing much wrong with that (apart from the hideous marketing-speak about “leveraging the brand”) - except for a couple of minor caveats. First, it’s all well and good talking about increasing revenue, but it sounds a bit hollow after the club’s revenue has just declined. Also, it’s a bit rich to start talking about controlling salaries after they have reached £150m or, put another way, nearly 25% higher than the next highest wage bill in the Premier League (at Manchester United).

So exactly how close were Chelsea to reaching the promised land of zero profit? The £44.4m loss in the 2009 results was somehow presented as a triumph, purely because it was £21.3m smaller than the prior year. OK, the loss is lower, but it’s still a thumping great loss. Only Manchester City recorded worse figures in 2009 in their first year of (ironically) “doing a Chelsea”. The club’s press release described the revenue as “stable”, which actually meant that it fell £6.7m from £213.1m to 206.4m, reflecting the front-loaded nature of a sponsorship contract. This decrease is attributed to the “economic climate”, but should be a cause of concern when the other members of the Big Four all managed to improve their revenue, especially after a fairly successful season (Premier League runners-up, Champions League semi-finalists and FA Cup winners).

"The only way is up"

To be fair, operating expenses of £263.7m were also down £10.4m, but you could make a case that most of the £21.3m improvement in profits (a.k.a. reduction in losses) was due to non-core activities: profit on player sales was £6.4m higher; amortisation was £8.3m lower, reflecting a slow-down in player purchases; and termination payments to managers and coaches were £10.5m smaller. These severance expenses are described as “exceptional items” in the accounts, suggesting that the underlying loss is much lower, but it’s actually pretty much business as usual for Chelsea, when you see that they have made such payments in three of the last five years (£25.5m in 2005, £23.1m in 2008 and £12.6m in 2009), paying £61.2m to rid themselves of a succession of “failed” managers: Claudio Ranieri, Jose Mourinho, Avram Grant and Luiz Felipe Scolari. That’s a staggering amount, especially if you consider how successful Mourinho and Ranieri have been since leaving Stamford Bridge.

In the trading world, technical analysts are fond of the expression, “the trend is your friend”, and the club’s management are keen to point to losses reducing for four years in a row. Good stuff, but everything’s relative, and the starting point was the record deficit of £140m in 2005. Yes, the losses might be on a downward trend, but they are still enormous by almost anyone else’s standards. Back in 2005, Peter Kenyon talked tough, “Two years ago we were seen as streets paced with gold. That is over. Chelsea is now being run properly. The club is being run as a business.” Four years later, he repeated the message, “This is the fifth set of financial accounts since the takeover and Chelsea has made huge progress during that period as a football club and a business.”

Hmmm. I’m not sure that I would describe the progress as “huge”: in the period described by Kenyon, the losses did fall, but only from £87.9m in 2004 to £65.7m in 2008. Big deal. In fact, much of the improvement over the years has been due to a revised approach to buying and selling players. As Kenyon said, “We have consistently reduced our net transfer spend over the last five years and will continue this trend.” Following the record shortfall in 2005, losses have now reduced by £95.6m (from £140.0m to £44.4m), but almost all of this (£74m, nearly 80%) has come from the transfer market: profit on player sales is £40.4m higher, while amortisation on purchased players is £33.6m lower. Another £12.9m of the reduction is simply because of lower termination payments (£12.6m compared to £25.5m). In other words, only £8.7m of the improvement has come from the underlying business. In an era when television money has significantly increased, that’s an unconvincing performance. Another way of looking at this is to say the revenue growth of £57m has been as near as damn swallowed up by matching cost growth of £53m, leaving a net improvement of just £4m.

The club was also keen to emphasise the improvement in cash flow in the press release accompanying the 2009 accounts, “Disciplined management of capital expenditure has reduced the cash spend from £107.4m down to £16.9m”, largely due to the completion of major projects such as the training centre at Cobham. However, like the profit and loss account, the song remains the same: cash flow might be better, but it is still negative, as it has been for every year of the Abramovich reign. This is, of course, before “financing”, i.e. interest-free loans from the owner. Interestingly, the net cash outflow from operating activities of £13.1m 2009 is exactly the same as it was in 2004 – no progress at all.

"Shining example"

But it’s the wage bill that has hit the headlines for all the wrong reasons. As per Chelsea FC plc’s accounts, total payroll costs (excluding termination payments) increased by £4.5m from £148.5m to £153.0m and may be even higher this year following new deals for the likes of John Terry, Frank Lampard, Petr Cech and Michael Essien. Chelsea had seven players in the recent list of the top 50 highest football salaries by Portuguese agency Futebol Finance, which is more than Real Madrid and big-spending Manchester City and only behind Barcelona. Chelsea started as they meant to go on when the first wage bill of the Abramovich era in 2003-4 of £115.6m was more than twice as much as the year before £55.9m. At the time, Kenyon said that he would set some “aggressive” targets for reducing the payroll, but it’s actually increased since then by more than 30%.

This has resulted in a wages to turnover ratio of 74%, which is admittedly better than a lot of teams in the Premier League, but is worse than Chelsea’s stated target of 55% and is a long way behind Manchester United and Arsenal (excluding property development) with 44% and 46% respectively. So the players are well paid at Chelsea, but the directors don’t do too badly either or at least one director, whose remuneration was £2m in 2009. The accounts do not specify who this is, but it’s presumably Kenyon, given that the same amount was earned in 2008.

At least money can’t buy success. No, strike that, as the current Premier League table shows that actually it can. As we speak, the top three positions are filled by the three teams with the largest wage bills – in exactly the same order. Chelsea pay the most and lead the table, followed by Manchester United with the second largest payroll and then Arsenal whose salaries are third highest. In fact, the top seven places in the Premier League are occupied by the first six teams in the “wages league” plus Tottenham (who are 8th). It appears that there is an almost perfect correlation between wages and league success (at least, this season).

"Can Buy Me Love"

Arsene Wenger has described this as “half cheating”, explaining that, “Professional football is about winning and balancing the budget. I’ve always pleaded for financial fair play.” He continued, “What is not normal is not our wages bill, but their (Chelsea’s) wages bill. That should not be allowed.” It’s a fair point, though critics might argue that it’s a bit steep coming from Arsenal, whose annualised wage bill is now running at around £120m, which is not that far below Chelsea and a long way ahead of most other clubs. However, Wenger’s argument is valid from the perspective of the wages to turnover ratio, namely that clubs should not be permitted to subsidise inflated wage bills by injections from owners, but should cut their cloth according to their revenue.

To Chelsea’s credit, they have already embraced a more prudent approach. Abramovich’s arrival was characterised by a massive spending spree, the likes of which the English game had never seen, but he has been far more frugal in recent seasons. In his first three years at the club, he splashed out almost £400m on buying new players (£170m in the first year alone, when he essentially purchased an entire new team – plus substitutes), but has only spent about a quarter of that (£110m) in the last three years. The last big splurge came back in 2006, including the likes of Ashley Cole, Salomon Kalou and the ultimate vanity purchase Andriy Shevchenko. The only “big” names to arrive last summer were Yuri Zhirkov, Danny Sturridge and Ross Turnbull (on a free).

The new, more cautious strategy has also been witnessed on the other side of the trade: in the first three years, Chelsea made a £6m loss on player sales (partly due to writing-off Adrian Mutu’s contract after his drug test), but have made a £60m profit in the last three years, mainly thanks to the sale of Arjen Robben to Real Madrid and three players to Manchester City (Wayne Bridge, Shaun Wright-Phillips and Tal Ben Haim).

"Praying for money?"

Manager, Carlo Ancelotti, has said that significant funds are available to him if required, but I think that the gentleman “doth protest too much”. In the January transfer window, he said, “Together we take the decision to maintain this squad, because we think this is a good squad. It’s not a question of money. Absolutely not. If it’s necessary to buy players, then we can do it”. Only last week, he was still on message, as he did not see any need for a summer spending spree, “I don’t think it’s necessary for us to spend a lot of money”. He is beginning to sound a lot like Arsene Wenger (“there is money to spend, but at the moment I am very happy with the squad I have”) and Alex Ferguson (“the money’s there if I want to buy someone”).

If a special player like Sergio Aguero or Kaka became available, it is possible that Abramovich would stump up the cash to get him, but it has become evident that the owner is concerned about the size of the club’s wage bill, most obviously with the protracted contract negotiations with the aging Michael Ballack and injury-prone Joe Cole. They could well be allowed to leave the club on free transfers, unless they accept drastically reduced terms.

This revised strategy has been reflected in the players’ valuations. In the balance sheet, intangible assets (basically net book value of the players) have decreased by £65.8m from £143.6m to £77.8m in just twelve months. The accounting treatment might be highly theoretical, but even an “independent” assessment by officers of Chelsea FC has slashed the valuation by £40m from £287m to £247m, based on estimates of what could be realised in the transfer market.

"Ballack gets shirty"

This explains Abramovich’s concerns, as he has been hit by the double whammy of a squad diminishing in value while continuing to command the highest salaries in the country. In terms of cashing in on the players, most of them are well past their sell by date with six players in their thirties when next season starts: Ballack, Drogba, Carvalho, Lampard, Anelka and Malouda (Terry and Ashley Cole are just short at 29). Even though the team may well win the Premier League, this is a team that needs rejuvenation if they are to deliver the Champions League success that Abramovich craves. What is certain is that this will not be funded by player sales – just look at Shevchenko, bought from Milan for £30m in 2006, moved to Dynamo Kiev on a free in 2009. It is not easy for any club to replace many key players at the same time, as Arsenal fans well know, following the break-up of the “Invincibles”.

One route that the Gunners have followed is to develop youth players that can break into the first team, but this has proved difficult for Chelsea to emulate. Frank Arnesen’s academy has hardly been a glittering success and the Dane was strongly criticised by Mourinho for not producing a single player that regularly started for the first eleven since his arrival in 2005. This remark might have been down to politicking by the notorious “Portugeezer”, but there was a tacit admission of failure when over half of the club’s worldwide scouting network was sacked. And that’s without mentioning the “tapping up” accusations.

"Wake-up call"

As we have already seen, the squad rebuilding cannot be financed from profits, for the very good reason that there aren’t any, so it will once again come down to the willingness of the owner to open his wallet. As that man Wenger said, “The only difference is that Abramovich can go out tomorrow and change ten players, because he has the financial potential to do it. But if Chelsea were run like any other club, they couldn’t do it.” Leaving aside the fact that Manchester City can now also do the same, Wenger is right to stress the importance of Abramovich to Chelsea’s fortunes.

The question is whether the Russian is willing to inject even more cash into Chelsea. After all, his personal spending on the club since he took over in 2003 is now over £700m. In the first year, Kenyon said that Abramovich’s purchase was “a serious investment with a long-term business plan”, but the oligarch has had to put his hand in his pocket every year since. Accusations that Abramovich had “lost his interest and enthusiasm” first emerged in 2007 and Mourinho was just the person to rub salt into the wounds after his Inter team eliminated Chelsea in this season’s Champions League, “He is not the same person. Probably he thought it would be easy when he arrived in football.” Not unnaturally, Carlo Ancelotti refuted this, “Roman is very interested, for sure, in his team. He likes football, Chelsea, the players and he wants to know everything – about injuries, the balance of the team, tactics.”

"You don't know what you're doing"

The reality is that Abramovich is still there. Perhaps the best example of his support is that he has converted his loans into equity, effectively making the club free of debt. Last year he halved the club’s debt with a £370m conversion and followed that up with another Christmas present in 2009 by doing the same for the outstanding £340m. When asked whether Abramovich would ever ask for his loans to be repaid in 2007, Peter Kenyon had replied, “As chief executive, I want to pay him back, because that would show we are running this club as a real proper sustainable business.” Although the Russian’s grand gesture made a mockery of these comments, a grateful Chelsea chairman, Bruce Buck, said, “There should now be no doubt as to the owner’s commitment to the club.” This had already been amply demonstrated by the interest-free nature of his loans, meaning that Chelsea paid less than £1m interest last year, compared to the eye-watering £68m at Manchester United, £37m at Liverpool and £20m at Arsenal. That’s what I believe is called a competitive advantage.

Some have commented that the debt conversion would make it easier for Abramovich to sell the club, as an investor would no longer be acquiring a mountain of debt, but that obviously does not imply that the club is on the market. At first glance, the timing does seem rather strange, as it doesn’t really make the club any more secure, unless you believe that Abramovich was thinking of calling in the loans at some stage.

"Good brand values?"

Bruce Buck provided a more likely reason for reducing the club’s debt, which was “to comply with any regulations on debt levels which are being discussed by the football community”. This was his oblique reference to UEFA’s Financial Fair Play initiative, which will come into force for all clubs involved in European competitions from 2012-13. However, it is far from clear whether Abramovich’s actions will be sufficient, as UEFA want to ensure that all clubs break-even and be self-supporting. They have explained that their intention “is to stop clubs making losses consistently, and having a backer to pay them off. That way of funding clubs, from outside owners, inflates players' wages, and too often an owner finds he cannot fund the losses any more and the club is in crisis, (which) is not sustainable for football”.

Therefore, Chelsea do need to explore ways of hitting the elusive break-even target and one route is to increase revenue. The long-term objective was always to turn Chelsea into a global brand (like the franchise that is known as Manchester United). There has been some success in increasing sponsorship revenue, mainly as a result of switching shirt supplier from Umbro to Adidas, but Chelsea’s commercial revenue of £52.8m still lags behind United at £70.0m and £67.7m at Liverpool. Ron Gourlay has spoken about selling naming rights for Stamford Bridge, which might generate an additional £10m a year. There’s obviously room for growth here, but the off-pitch scandals involving “JT” and “Cashley” Cole don’t exactly promote the Chelsea brand.

"Bridge of Sighs"

The club’s capacity to make more match day revenue is constrained by, er, their capacity of 42,000 at Stamford Bridge, which is considerably lower than Old Trafford (76,000) and the Emirates (60,000). Nevertheless, they do get a lot of bang for their buck with revenue of £74.5m, which is much higher than Liverpool’s match day revenue of £42.5m, even though Anfield’s capacity is actually larger with 45,000. They have held prices steady for a couple of seasons, but apparently maximise the corporate revenue. However, their only realistic hope of matching the £100m+ earned by Manchester United and Arsenal would be to move to a larger stadium and that appears to be off the agenda for the moment, as no feasible alternative site has ever been realistically identified.

Broadcasting revenue is already pretty good at £79.1m, second only to Manchester United in England, but may be a bit lower this year after the earlier exit in the Champions League. In line with other teams in the Premier League, Chelsea will benefit from the new agreement on overseas rights, which will deliver an extra £7.5m per annum for the next three years. Apart from this revenue stream (and even this may be endangered in future years by Ofcom’s ruling that Sky should charge less for their sports packages), it is not easy to see how Chelsea can grow their revenue sufficiently to hit break-even. As Deloittes said in their annual review, “the club faces a significant challenge to regain a top five position in our Money League.”

"Still interested?"

Hence, the continued reliance on Roman Abramovich even now, despite Kenyon’s grand five-year plan to reduce dependency on the Russian. This cannot be a sound business model. Even chairman Bruce Buck had to admit, “No matter how much money the man has, and I don’t know how much, at some point he is not going to want to invest more money in the club.” Clearly, Chelsea’s benefactor is not short of a few bob. Last year, his fortune was reported to have declined by 40%, but he was still worth £7 billion according to the Sunday Times Rich List and he must have increased his net worth in 2010 following the stock market recovery. However, even the wealthiest businessman is not invulnerable and Abramovich is currently facing a £2 billion court claim from former business partner Boris Berezovsky. Although it is unlikely that Abramovich would ever abandon the club for financial motives, Chelsea would be in serious strife if he exited stage left – for whatever reason. At the very least they would have to find another source for their borrowing – and might even have to pay standard rates of interest.

So will Chelsea finally manage to break-even? I’m afraid that the answer has to be “yes” and “no”. If you look at the bottom-line loss of £44.4m in 2009, it looks improbable, but it is certainly possible if you consider the narrow profit definition used by Peter Kenyon, “We have set ourselves ambitious targets to be EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortisation) neutral on June 30 2010.” On this basis, Chelsea’s 2009 loss was only £11.4m, so they are in with a fighting chance, though it does bring to mind the old saying about moving the goal posts.