Why You Shouldn’t Take The Forbes Soccer Valuations Seriously

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 Rankings

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:

Forbes 20 Most Valuable Soccer Clubs - 2012

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.

So…

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.

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Why You Shouldn’t Take The Forbes Soccer Valuations Seriously

2 thoughts on “Why You Shouldn’t Take The Forbes Soccer Valuations Seriously

  1. I get your point, but I don’t think DCFs or any sort of valuation methodology used in banking are applicable in this situation. Like you said, they are inherently forward thinking, but they are also heavily based on assumptions. I don’t think that you could ever give credit to Forbes even if they used DCFs because everyone’s projection of a club’s success is different.

    Say you started working for Forbes and revolutionized their valuation methodology, you might say Sir Alex’s assumed retirement sometime in the next few years has to be factored negatively into the future cash flows, assuming indeed that performance has an inverted correlation with revenue. I might disagree with you saying the even with Sir Alex’s retirement, the high intangible value of the United brand will continue to keep competition for corporate sponsorship of United very high for at least the next 10 years. In turn, their long-term sponsorship revenue and gate receipts, which comprise a substantial majority of their revenue, would remain unaffected for sometime. And then someone else might disagree with either of us and have a different opinion.

    The issues don’t end there. If you were to have done the Forbes rankings as you see fit, you wouldn’t have placed Manchester City on your rankings five years ago. Or Anzhi Makachkala. Or Paris Saint-Germain. But now you would have to since their balance sheet has been externally inflated with unforeseeable cash injections. So would your rankings of the top 20 most valuable clubs at the time been truly accurate? If you were to do it today, whose to say that your rankings would be more accurate than Forbes, given the possibility that a club like Wigan Athletic or Real Zaragoza be acquired?

    What I’m saying is that while I see your issue with Forbes using fundamental multiples to rank the value of clubs, its would almost be impossible to get a more credible ranking with a more sophisticated valuation system, because those rely heavily on individual opinion as well as the volatile nature of club ownership in our current times.The only way I see it working to my satisfaction is if the future years to forecast is limited to five or less, effectively mitigating the possibility for significant variable change. But even that in itself is a manipulation of sorts and cannot be regarded a truly credible valuation of a club’s intrinsic value. And we are still left with the issue of proper assumptions.

    1. I agree with you, valuation is opinion. It requires making assumptions which are often subjective and sometimes inaccurate but that is better than not trying at all. Take your SAF retirement example, let’s say I think that United will drop in value after he leaves but you don’t think so. Our valuations are different and only one will be closer to the true value, BUT they are both better than an analysis which doesn’t even bother to take the event into account and just draws a straight line from historical data.

      re: Anzhi, Man City etc. Valuation is a stab at uncovering economic reality given the available info at the time. Of course no one could have told you 5yrs ago that Anzhi was going to be handing out gold-plated toilets today, but that doesn’t make an analysis done then any less correct at the time. You control for what you can and have to commit to a methodology at some point.

      Long story short, I am not calling Forbes out because I think it’s valuation is wrong but because IMO it is not doing valuation at all.

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