The 2012 edition of the Forbes Soccer Club Valuations are out. You may recall that I am not a huge fan of them so I thought I’d take a post to cover more in depth why I am incredibly dismissive of this annual list.
Forbes does a number of lists which rank various aspects of the financial world, from the richest people in the world to the most valuable companies, this includes soccer clubs. To do this the magazine throws available financial data, its own research, and some expert opinions into a black box shakes it around and out come values for clubs. Simple enough right? When you look at the ranking the list is populated with familiar names and the order looks about right:
Wikipedia has a good compilation of the rest of the Forbes Soccer Club Valuations since 2007. So what’s the problem?
What are we talking about here?
First, a definition to make sure we’re all on the same page. Valuation is the art of determining the economic value of an asset. Doing so requires making sense of and discounting for the uncertain financial future. A dollar in a year is more risky than a dollar today. A valuation is inherently forward looking, there is no point in a valuation that looks backwards as that is simply accounting.
In the case of soccer, the value of a club is dependent on the income an investor can expect from owning the team. The income, and consequently the value, fluctuates as unexpected things happen. Any analysis of value therefore needs to take into account a club’s future revenue, costs, capital base etc. as well as adjusting for uncertainty.
The Forbes methodology…?
If Forbes does take into account those variables it is unclear how they are incorporated, unfortunately it seems unlikely that they are considered. In fact it’s just as difficult to know how the included variables are used, as the methodology discussion is quite light on numbers or, well, any methodology at all really:
We began our valuations with the Football Money League report, published by the Sports Business Group at Deloitte, which compiles vital figures for the 20 soccer teams with the most revenue. We then use our own research, which includes reviewing financial documents and speaking to sports bankers, to derive operating income, debt and values for each team.
Note that this peek into the valuation black box is even vaguer than the last time I wrote about the Forbes list. Unfortunately, the exact model is going to remain a mystery barring a Tom Cruise like break-in to the secret Forbes computation center, but the data provided do hint at what is considered important.
Ze revenues, zey do nothing
The Forbes model is heavily biased toward revenue. Within the data the most consistent metric over the past five years is the Price/Revenue (P/Rev) multiple. P/Rev is a basic measure of the valuation of a business relative to the gross money coming in, the higher the P/Rev multiple the more aggressive the valuation is considered. As an example, imagine two gumball machines that take in the same money each week, if one owner is looking to sell his machine at twice the price compared to the other his valuation would be expensive on a relative basis. With that in mind here are the P/Rev multiples for the past six years:
The club valuations are highly correlated with revenue, increases in revenue translate quite directly into increases in valuation. Also, a club’s individual multiple stays roughly the same throughout its history. If you look at Chelsea and Marseille you see that they are consistently priced around a multiple of 2 and 1.5 respectively. There are two major problems with using a model heavily dependent on revenue.
First, revenue in soccer is highly volatile and, unless you are United, does not exhibit steady growth rates. Almost all revenue streams (season tickets/gates, matchday revenue, commercial deals, league payments) are directly tied to performance exactly the opposite of a shock absorber; when the team does well revenues grow, but when the team plays poorly falling revenues compound pressure on the club.
Second, looking at revenues in isolation is meaningless. It is fairly obvious that a club with the highest revenue in the world and minimal costs is worth a lot more than one that has the highest costs in the world to match.
Ze earnings, zey definitely do nothing
The weakness of a revenue model would be mitigated by incorporating income as it is possible for a club which brings in less revenue to earn more income depending on its cost base and management. In this case Forbes chooses to use Operating Income or Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA). EBITDA in this case is club income before it has to pay interest on any financing arrangements and any income or loss on player trading.
As I did with P/Rev I went looking for the P/EBITDA multiple to get an idea of what relation the Forbes valuation had to it. Here are the P/EBITDA multiples:
The same correlation and consistency we see in P/Rev is not found when looking at P/EBITDA, in most cases it fluctuates wildly from year to year which suggests it does not factor heavily in the valuation calculation. Let’s look at an individual case:
In the case of Inter Milan for the 2008-09 season its valuation increased by $43m over the previous year despite posting an operating income loss of -$14m, in the 2010-11 season the valuation increased by $51m despite a loss of -$84m!
Worst of all
Another major problem is that the valuations are internally inconsistent and no reasoning is provided as to why. What is the basis for Manchester United to be consistently priced at a higher P/Rev multiple (4) compared to Barcelona (2)? Barcelona is also valued more cheaply on a P/EBITDA basis:
So why are Catalonians discounted relative to Mancunians? There maybe a very good reason, but without explanation opaque quickly turns into arbitrary.
Perhaps the most damning thing about the Forbes valuations is that they are completely backward looking. As I said before: valuation is inherently forward looking, there is no point in a valuation that looks backwards as that is simply accounting. Unless past trends can be reasonably expected to continue into the future there is nothing instructive about them. As an example let’s turn to United again, it is currently the most richly priced club in the ‘league’ and on past performance it would appear completely justified.
However, there is the rather large cliff that is Sir Alex Ferguson’s retirement coming up, something that is sure to affect performance (and revenues). Does this not justify some kind of discount to bring United’s valuation back in line with other clubs? The reason there is no discount is because the valuations are not looking to the future. Instead they are like a driver navigating through the rearview mirror, bound to fail at the first turn in the road.
There is nothing wrong with reviewing and even ranking the financial status of clubs. It is something that the excellent Deloitte Money League does every year, but what the Money League does not purport to do is provide insight into the grey world of club valuation. It knows better.
Maybe Forbes has a highly developed valuation model that is taking in thousands of inputs and has projected all the future revenue situations I talked about. Maybe it can be argue that a club is worth whatever someone will pay for it according to the Greater Fool Theory. But what I see is a vast oversimplification of an extremely complex and illiquid market that makes for a nice bit of entertainment.