4. The Financial Analysis
4.5 Leverage and coverage
The purpose of this section is to analyze BIF’s leverage, coverage to see if there are sufficient financial resources to keep the company running in the future.93
Leverage: From 2006 to 2010 BIF’s D/V ratio increased slightly from 57,1% to 60,8%, as seen in the figure below. During the period the ratio had some deviations from this level, and ranged from 49,6 as the lowest in 2007 to 66,8% in 2009 where it peaked. In average is has been 58% which is a quite high level compared to other industries.94
It is also relevant to compare the ratio to the competitor’s, to assess whether BIF has more or less leverage than these. Since Koller, et al (2009) suggests using market values instead of book values, the only comparable competitors are the ones that are listed on a stock exchange (the market share price is needed in order to calculate the market value of equity). Unfortunately there are only 5 of this kind in Denmark, which limits the range considerably. In this calculation, Aalborg BK (AAB) and Aarhus Gymnastik Forening (Århus Elite) are used, since FC Copenhagen and Silkeborg IF, the remaining two stock listed clubs, have too wide spread activities to be comparable. Comparing to only two competitors is not optimal, and it makes it hard to generalize from the numbers. It seems to be the case that the football industry has a high D/V ratio in general, and that BIF is in the high end. Århus Elite’s average has been 29,3% and therefore significantly lower than BIF’s, and AAB’s has been 65,3% which is slightly higher than BIF’s.
Figure 17 – BIF’s and two competitor’s debt to value ratios (D/V)
Source: Data from BIF’s, AAB’s and Århus Elite’s annual reports 2006-2010
93 (Koller, Goedhart, & Wessel, 2010, pp. 179-180)
94 (Koller, Goedhart, & Wessel, 2010, p. 268)
2006 2007 2008 2009 2010 Average
BIF 57,1% 49,6% 55,6% 66,8% 60,8% 58,0%
AAB 46,3% 49,6% 62,9% 79,8% 87,9% 65,3%
Århus Elite 37,8% 16,7% 48,6% 21,9% 21,8% 29,3%
Page 42 of 85 Based on the relatively high D/V ratio it is concluded that there is a high financial risk combined with BIF. To show how a high leverage (D/E – debt to equity), which is basically the same concept as D/V, brings higher risk to a company’s investors, the following formula is addressed. It shows how Return On Equity (ROE) is connected to ROIC and leverage:
A company can raise its ROE in two ways. It can happen either from improving the ROIC (through operating improvements) or from increasing the D/E ratio (by swapping debt for equity). Using the second option, seems appealing at first sight, since it will bring more value to the shareholders. But, increasing the D/E will make ROE more sensitive to changes in operating performance (ROIC). Hence, increasing the ROE through changing the leverage comes with a price - it increases the risk faced by shareholders. Therefore, a company with a high leverage (or D/V ratio) faces a higher risk than a company with lower leverage.95
Liquidity and coverage: Companies go bankrupt when they fail to honor payments they have committed themselves to. Therefore it’s important to gain knowledge about the company’s liquidity situation in order to assess its financial health. A rough way of measuring this is the current ratios seen in the figure below.
Figure 18 – BIF’s Current ratio
Source: Data from BIF’s annual reports 2006-2010
This ratio is calculated by dividing the reduced current assets by reduced current liabilities (see appendix 4).
Reduced current assets are the assets that can be turned into liquidity within a year, and reduced current liabilities are the liabilities than can reduce liquidity within a year. In other words, the current ratio shows the company’s short term solvency.96 According to Schack (2009) the rule of thumb is that the current ratio should be above 2, in order to be good97. This guideline is only supposed to be seen as a rough guideline though, and not a rigid rule. In 2006 BIF’s current ratio were 0,79, then it decreases to a critical level in 2007 and 2008, where the club’s reduced current liabilities are much higher than the reduced current assets, but from 2008 and forth a positive development is seen, and in 2010 the ratio reached “1”. Bad
95 (Koller, Goedhart, & Wessel, 2010, p. 181)
96 (Schack, 2009, p. 85)
2006 2007 2008 2009 2010
BIF's Current ratio 0,79 0,25 0,31 0,74 1,00
Page 43 of 85 liquidity, like seen in 2007 and 2008, means that a company has only little flexibility when it comes to financing new investments, but the positive development in 2009 and 2010 indicates that BIF is moving away from this problem.
According to Schack (2009), examination of the current ratio can’t stand alone when analyzing a company’s liquidity situation though. Key figures based on the cash flow statement have to be analyzed too, in order to assess the company’s ability to cover the most urgent payments with operating profits. In the figure below, two such coverage ratios are calculated.
Figure 19 – BIF’s coverage ratios
Source: Data from BIF’s Annual reports 2006-2010.
The first one, EBIT/Interest, measures the company’s ability to pay interest using profits without cutting capital expenditures intended to replace depreciated equipment (in BIF’s case, also players).98 In order to consider this ratio as good, Schack (2009) states a rule of thumb that says it has to be significantly above 1.
This would mean that the company has no problems paying the interest with the profits it makes itself. In 2006 it measured 10,92 which is good, but in the remaining years it ranges between -3,19 and 1,19 which reveals that the company has had troubles creating enough profit to cover the interest.
To analyze the situation further, the second ratio, EBITDA/interests, is calculated. It measures the company’s short term ability to pay interest using both current profits and the depreciation kroner earmarked for replacement capital.99 The fact that the ratio is positive and well above 1 during all years, means that in the short term BIF is capable of paying the most critical financial commitments. In the longer run though, a company has to make profits large enough so that it can replace capital, or else it cannot compete effectively. This can become a problem for BIF in the future, if the development doesn’t change.
Conclusion on the financial analysis
BIF’s growth has been lower than its competitors, and the boom from 2008 might not be sustainable, since the sponsor deal with Jesper Nielsen was terminated ultimo 2010 and the lucrative TV-deal ends medio 2012.
98 (Koller, Goedhart, & Wessel, 2010, p. 180)
99 (Koller, Goedhart, & Wessel, 2010, p. 180)
2006 2007 2008 2009 2010
EBIT/Interest 10,9 -1,2 -0,8 1,2 -3,2
EBITDA/Interest 15,6 2,7 4,4 8,4 3,0
Page 44 of 85 Because of the high volatility, the “weak” connection between profits and revenues and the short historic period of analysis, it makes sense to question whether the revenue CAGR calculated in this chapter is representative for the future growth rate, and whether growth in revenues is a good proxy for growth in the cash flow used in the valuation process (FCF). Nevertheless, it’s the best estimates available. The more detailed expectations regarding the future growth rate are elaborated in section 6.2.
From 2006 to 2007 ROIC fell dramatically, but after this shock, it settled at a low but rather constant level.
By decomposing the pretax ROIC it was found that decreasing profitability caused a negative effect from 2007 to 2010, but an increasing rate of turnover more or less netted this out. Furthermore the significant difference in ROIC from 2006 compared to the rest of the years, highlights a football club’s dependency of good results on the field and derived player sales in order to make profits.
As for the growth, the more detailed expectations regarding the future performance are elaborated in section 6.2.
Based on BIF’s high leverage, low interest coverage and bad (though improving) current ratio, the overall financial health is estimated to be bad. The club could be forced to issue new shares in order to raise capital, which according to the pecking order, is the least favorable way of financing new investments.100