Manchester City - I Threw A Brick Through A Window

So Manchester City are once again spending big, with this summer’s transfer window seeing the arrivals of Kevin De Bruyne, Raheem Sterling, Nicolas Otamendi, Fabian Delph and Patrick Roberts. This should have come as no surprise given comments from chairman Khaldoon al Mubarak earlier this year, “We want to go to the next level and a squad that has the capability and quality to win the Premier League and compete in and win the Champions League and go all the way in tow cup competitions in England.”

However, the question on everyone’s lips was how could they do this without falling foul of UEFA’s Financial Fair Play (FFP) regulations? There have been a few articles attempting to provide an answer, but they have tended to focus on the generic issues with FFP, while this piece will attempt to look at the specifics for City.

After an initial period of major investment following the club’s purchase by Sheikh Mansour, which peaked with £155 million of gross spend in 2010/11, City had been reducing their activity in the transfer market (relatively speaking) until this summer’s £142 million outlay.

Interestingly, City’s gross spend in the last five years of £462 million (averaging £92 million a season) is almost exactly the same as the £456 million spent in the previous five years – though most of this (£407 million) was incurred in the three years after the new regime arrived in September 2008.

Of course, there are two sides of a market and City managed to recoup £51 million through player sales, giving a net spend of £91 million. Obviously this is still on the high side and most clubs can only dream of such a level of expenditure, but it’s not quite so dramatic as the gross spend figure widely reported. It is also worth noting that this is the highest annual player sales figure achieved to date by City.

To an extent City have been playing catch up this summer, as UEFA had imposed restrictions on their transfer spending last year. Nevertheless, City still have the highest net spend over the last two season of £151 million, though Manchester United are pretty much at the same level with £145 million, as Moyes and Van Gaal have both endeavoured to reinvigorate their squad following the departure of Sir Alex Ferguson.

Both Manchester clubs are a long way ahead of the other Premier League clubs in terms of net spend with the closest challengers being Arsenal £74 million (around half as much), Newcastle United £62 million and Liverpool £57 million.

At this stage we have to get a little technical in order to understand how football clubs accounts for player trading, as this is important for FFP. The fundamental point is that when a club purchases a player the costs are spread over a few years, but any profit made from selling players is immediately booked to the accounts.

Basically, football clubs consider players to be assets, so do not fully expense transfer fees in the year a player is purchased, but instead write-off the cost evenly over the length of the player’s contract via player amortisation – even if the entire fee is paid upfront.

So if a player is purchased for £25 million on a five-year contract, the annual amortisation in the accounts for him would be £5 million, i.e. £25 million divided by five years. This means that the player’s book value reduces by £5 million a year, so after three years his value in the accounts would be £10 million, i.e. the original transfer fee of £25 million less £15 million cumulative player amortisation (three years at £5 million a year).

If the player were to be sold at this point for £32 million, the profit on player sales from an accounting perspective would be £22 million (sales proceeds of £32 million less remaining book value of £10 million). Another way of looking at this is that the cash profit is £7 million (sales proceeds of £32 million less £25 million purchase price), but we then add back the £15 million of player amortisation already booked to the accounts.

This is all fairly tedious stuff, but it does have a major influence on a football club’s bottom line and will help explain why City’s transfer activity this summer is still in line with FFP.

In this way, although City had gross spend of £141.5 million (De Bruyne from Wolfsburg £54 million, Sterling from Liverpool £44 million, Otamendi from Valencia £28.5 million, Delph from Aston Villa £8 million, Roberts from Fulham £5 million and Enes Unal from Bursaspor £2 million), the annual player amortisation shown in the books is “only” £26.5 million. As an example, De Bruyne’s £54 million is equivalent to £9 million amortisation, because he is on a six-year contract.

Caveat: these figures should only be considered as indicative, because various different numbers have been reported in the media for transfer fees (partly due to exchange rates used), but they should be sufficiently accurate to illustrate the argument. I have also excluded any transfer add-ons from the calculation, as these are dependent on future achievements, so are not immediately included in the accounts (except in the notes as contingent liabilities).

City’s wage bill will also increase by £31.7 million a year for these purchases (again based on widely reported weekly wages), leading to a total increase in annual costs of £58.2 million.

This works out to a total commitment over the length of the player contracts of a cool £310.5 million (plus £14.5 million of potential add-ons).

However, we now need to look at the impact of players leaving City, which has generated sales proceeds of £50.5 million (Alvaro Negredo to Valencia £24 million, Matija Nastasic to Schalke £10 million, Rony Lopes to Monaco £9 million, Karim Rekik to Marseille £3.5 million, Scott Sinclair to Aston Villa £2.5 million and Dedrick Boyata to Celtic £1.5 million).

In addition, City have received £5.2 million in loan fees (Edin Dzeko to Roma £2.9 million, Stevan Jovetic to Inter £2 million and Jason Denayer to Galatasaray £0.3 million), giving total receipts of £55.7 million. On top of that, there would be a further £18 million due for Dzeko and Jovetic if those deals were made permanent at the end of the loan periods.

After deducting the accumulated player amortisation, the once-off profit on player sales works out to £40.2 million. In addition, £8.3 million will be taken off the annual amortisation charge.

City have also removed a number of high earners from their wage bill via free transfers (that obviously did not generate a transfer fee), notably Frank Lampard, James Milner and Micah Richards, and player loans. On the assumption that the wages of the loanees will be covered by the other clubs this season, the annual wage bill will have been cut by £41.2 million, leading to a total cost reduction of £49.5 million.

So the net result of all of City’s transfer and loan activity this summer in the accounts is a relatively small increase of £8.7 million, with player purchases growing the cost base by £58.2 million, largely offset by the £49.5 million reduction arising from sales and loans. This will be more than offset by the £40.2 million profit on player sales.

As the late, great Sid Waddell once memorably said: “There’s only one word for that: magic darts!”

City’s initial spending spree was reflected by player amortisation shooting up from just £6 million in 2007 to a peak of £84 million in 2011, before tailing off in the last three years to £76 million in line with less frenetic transfer activity.

That said, this was still the highest in the Premier League in 2014, followed by Chelsea £72 million, Manchester United £55 million, Liverpool £41 million, Arsenal £40 million and Tottenham £40 million. As we have seen, this summer’s renewed spending will likely increase this once again.

Now that people have a basic understanding of how player amortisation works, you might think that next year’s accounts should also benefit from the player amortisation on the major purchases in 2011 coming to an end (assuming five-year contracts). Normally this would indeed be the case, but there is a further complication at City, as they have frequently extended player contracts.

In such cases, any remaining written-down value in the accounts is amortised over the term of the new contract, which means that the annual amortisation reduces, but the amortisation life is longer.

As an example, Yaya Toure was bought for £24 million in July 2010 on a five-year contract, so the annual amortisation was initially £4.8 million, and should have finished in June 2015. However, after two years, his contract was extended in June 2012 by a further two years to June 2017, meaning that he then had five years left on his new contract. At this point, his remaining value was £14.4 million (£24 million cost less two years amortisation at £4.8 million). The new amortisation charge was thus £2.9 million a year, i.e. the remaining £14.4 million divided by the five years now left on the contract.

City have extended the contracts for virtually all the big players signed in 2010/11 at some point (either 2012, 2013 or 2014), which has had the advantage of reducing the annual amortisation charge in recent years, but has the disadvantage of extending the period for which these players’ transfer fees are amortised.

The good news is that (by my calculations) the 2014/15 accounts would have benefited from a £14.4 million reduction in amortisation, but the amortisation on these players will not fully disappear until the 2019/20 accounts.

City will continue to focus on their wage bill, which already fell by 12% (£28 million) in 2014 from £233 million to £205 million. This meant that the wages to turnover ratio had been lowered (improved) from 114% in 2011 to an impressive 59%.

The magnitude of the 2014 wages reduction has raised a few eyebrows, especially as the number of football staff was slashed from 222 to 112. This is essentially due to a group restructure, where some staff are now paid by group companies, which then charge the club for services provided. This accounting treatment has attracted the attention of UEFA, as some have accused City of using this as a device to get round FFP.

UEFA have still to rule on whether this is a reasonable approach, but it should be noted that many of these costs have simply been booked elsewhere in City’s accounts, i.e. external charges rose £17 million from £42 million to £59 million in 2014.

In addition, there are a couple of underlying reasons to explain the year-on-year reduction: (a) the 2012/13 figures included compensation paid to Roberto Mancini and his coaching staff following their termination – which other clubs usually report under exceptional items; (b) chief executive Ferran Soriano has renegotiated a number of contracts with a lower basic salary, but higher bonus payments.

Whatever the rights and wrongs of City’s reported wages, they have been overtaken by United, whose wage bill rose to £215 million in 2013/14. However, City’s £205 million is still £12 million higher than Chelsea £193 million and £39 million higher than Arsenal £166 million. It should be noted that one of the clauses in UEFA’s FFP settlement with City stated that they could not increase their wage bill during the next two financial periods (2015 and 2016) – though performance bonuses are not included.

What is often overlooked when discussing FFP is that it is just as important for football clubs to grow their revenue, as well as restraining costs. City have done very well here, increasing their revenue by around 300% since 2009 – and there is more to come in every revenue stream: TV - through higher Premier League and Champions League deals; commercial - from renegotiating the shirt and kit sponsorship; and match day - after expanding the stadium.

City’s 2013/14 revenue of £347 million was the second highest in England, only behind Manchester United £433 million, and ahead of Chelsea £320 million, Arsenal £299 million and Liverpool £256 million.

This placed them 6th highest in world football, though Real Madrid continued to lead the way with £460 million, followed by United £433 million, Bayern Munich £408 million, Barcelona £405 million and Paris Saint-Germain £397 million.

The currency effect should be noted here, as last year’s Deloitte Money League used a Euro:Sterling exchange rate of 1.20. If recent rates of 1.40 were to be applied, that would have a significant effect on the overseas clubs in Sterling terms, e.g. Real Madrid’s revenue would fall to £393 million. This Euro weakness partly explains the high level of purchases made by English clubs this summer.

However, the main driver of the big spending in England is clearly the money expected from the blockbuster Premier League TV deal in 2016/17. City already received £98.5 million from the central distribution in 2014/15, but my estimates suggest that their second place would be worth an additional £51.5 million under the new deal, increasing the total received to £150 million. This is based on the contracted 70% increase in the domestic deal and an assumed 30% increase in the overseas deals.

Similarly, Champions League TV money has increased from the 2015/16 season with the new deal worth an additional 40-50% for participation bonuses and prize money and further significant growth in the TV (market) pool thanks to BT Sports paying more than Sky/ITV for live games.

In 2013/14 City received €35 million from the Champions League, while I estimate that they will earn around €7 million more (€42 million) for the 2014/15 season, even though they reached the same stage (last 16) in both years.

This is because  City’s share of the UK market pool will be higher, partly as this did not have to be shared with a Scottish club in 2014/15 (as was the case in 2013/14 with Celtic), but also how this is calculated. It party depends on how far they progress in the Champions League, but is also dependent on where they finished in the previous season’s Premier League (which they won in 2013/14, compared to finishing runners-up the year before).

If City reach the same stage in the Champions League in the 2015/16 season, this could be worth an additional €20 million under the new BT deal, though this will be adversely impacted in Sterling terms, due to the weaker Euro.

City also have the potential to further increase their commercial income – even after impressive growth over the past five years to £166 million, which in England has left them only behind Manchester United’s commercial juggernaut that produced £189 million. Critics will argue that this is built on friendly deals with Arab partners, but the fact is that City are now signing up many other deals not linked to their owners.

In any case, the groundbreaking 10-year £400 million deal with Etihad Airways, covering shirt sponsorship, stadium naming rights and the campus development, now looks to be behind the market, as other clubs have since raised the bar. It is estimated that the shirt sponsorship element of City’s deal is worth £20 million a season, which would put City’s deal way below their competitors: Manchester United – Chevrolet £47 million ($70 million); Chelsea – Yokohama Rubber £40 million; and Arsenal – Emirates £30 million.

In fact, there has been talk of City renegotiating the Etihad deal upwards to reflect their higher commercial value after two Premier League titles and regular Champions League participation. Some reports have speculated that the value could even double to £80 million a season.

There are also rumours that City are trying to negotiate upwards their £12 million kit supplier deal with Nike, even though their current six-year contract only started in 2013. There is certainly room for improvement, as this is now well behind other clubs’ latest deals: United £75 million (Adidas), Arsenal £30 million (PUMA) and Liverpool £25 million (Warrior).

Finally, City have wised up to the fact that it is better for FFP to have numerous smaller deals (around the £3-5 million range) flying under UEFA’s radar, so have been racking these up, thus emulating a key element of United’s successful commercial strategy.

For the 2015/16 season City have increased the capacity of the Etihad Stadium by 7,000 seats to 55,000 after adding a third tier to the South Stand, which should result in higher match day income following record season ticket sales of 40,000. They have also received planning permission for potential further expansion up to 62,000 by doing the same for the North Stand.

Although this revenue stream has been on a rising trend, City’s £47 million is till less than half the money generated by United and Arsenal (both over £100 million), partly due to City season tickets being among the cheapest in the Premier League.

After years of heavy spending in order to build a squad and the facilities required to compete at the highest level, City’s losses have been steadily reducing since the £197 million peak posted in 2011, effectively halving each year (2012 £99 million, 2013 £52 million and 2014 £23 million). In fact, the club has said that it should already be profitable in 2014/15, partly because the 2013/14  loss included the £16 million settlement with UEFA over (disputed) breaches of its FFP regulations

Financial Fair Play has obviously been one of the most important challenges for Manchester City. According to UEFA’s interpretation of the regulations, particularly the exclusion of costs of players purchased before 2010, City failed to meet the break-even targets and as a consequence were fined €60m (£49 million) of which €40m (£33 million) was suspended.

Other measures included “significantly” limiting spending in the transfer market for seasons 2014/15 and 2015/16, not increasing the wage bill in 2015 and 2016 and a limitation on the number of players City could register for UEFA competitions.

"De Bruyne - X marks the spot"

City were also given specific targets for FFP losses of €20 million in 2013/14 and €10 million in 2014/15, as opposed to the cumulative allowance of €30 million over those two seasons for all other clubs. In reality, this should not have been a major issue, as City were allowed to exclude infrastructure costs and the £16 million FFP settlement for the 2013/14 FFP loss, while they had always planned to be profitable from 2014/15 onwards.

Indeed, the FFP restrictions were duly lifted in July, though UEFA did note that this was “subject to ongoing additional controls and audits”, adding: “the club remains under strict monitoring and has still to meet break-even targets and is therefore subject to some limitations in 2016.”

Some have suggested that the FFP rules are being relaxed in light of the various legal challenges, but the truth is a little more complicated than that. Although new owners will now be allowed to make larger losses, as long as they can produce a business plan that will show how they will reach break-even, the rules remain in place for clubs like City. Essentially, UEFA are now arguing that the modified stance is a move from “austerity to sustainable growth” in an effort to encourage investment into European football.

"Silva and Gold"

The irony here is surely not lost on City fans, as they have effectively been punished for embracing exactly this strategy, while others (like Milan and Inter) will now be able to benefit from the more flexible approach.

Maybe UEFA had been listening to City captain Vincent Kompany, who had previously commented on the flaws in FFP: “If you go into the business world, you can’t say to anyone they cannot invest. I understand the fans have to be protected, the clubs have to be protected, but plans need to be accepted. You win things, you get more fans. You get more fans, you create more revenue. That’s not a stupid way of thinking, of investing in a business.”

One argument against FFP has been that it sometimes seemed more of an attempt to prevent upstarts like City (and Paris Saint-Germain) from taking on the established order of elite clubs, rather than tackling the game’s financial issues. Either way, the regulations have undoubtedly caused City some headaches.

"Train of thought"

Manager Manuel Pellegrini complained last year that transfer restrictions meant that his club was not competing on a level playing field, which supporters at other less wealthy clubs might have found a bit rich, given previous expenditure but in a way he had a point. In any case, that excuse is no longer valid after this summer’s spending spree.

Leaving aside the financial issues for a moment, City have undoubtedly made some great purchases, including the exciting De Bruyne and Sterling, which will add significant depth to their squad. Whether this will be enough to help City meet the owners’ demanding objectives remains to be seen. The early signs are promising, as they have started the season like the proverbial house on fire, but older City fans in particular will know that there's an awful long way to go yet.