HBS Tottenham Case

Tottenham Case

Student: Petru-Catalin, David (10824618)

1a. What are the free cash flows Tottenham Hotspur expects from 2007 until 2020? Create a table. Assume that Net Working Capital increases in proportion with revenues (hint: excess cash should not be included in net working capital). Free Cash Flow Estimation (based on Exhibit 5 and additional information provided in the text) 0 1 2 3 4 5 6 7 8 Year 2007 2008 2009 2010 2011 2012 2013 2014 2015 Total Revenue 74.1 80.8 88.0 96.0 104.6 114.0 124.3 135.5 147.7 Operating Expenses (excl. Depreciation) (69.1) (74.9) (81.3) (88.2) (95.8) (104.1) (113.2) (123.2) (134.0) Depreciation (2.2) (2.3) (2.4) (2.5) (2.6) (2.7) (2.8) (2.9) (3.0) EBIT 2.8 3.6 4.4 5.3 6.2 7.2 8.3 9.4 10.6 Taxes (1.0) (1.2) (1.5) (1.8) (2.2) (2.5) (2.9) (3.3) (3.7) Depreciation 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 3.0 Capital Expenditure (3.3) (3.4) (3.6) (3.7) (3.9) (4.0) (4.2) (4.3) (4.5) Change in Working Capital 3.8 4.2 4.5 4.9 5.4 5.9 6.4 7.0 Free Cash Flow 4.98 5.81 6.70 7.68 8.72 9.84 11.06 12.35

9 2016 160.9

10 2017 175.4

11 2018 191.2

12 2019 208.4

13 2020 216.8

(146.0) (3.1) 11.9 (4.2) 3.1 (4.7) 7.6 13.73

(159.0) (3.3) 13.2 (4.6) 3.3 (4.9) 8.3 15.21

(173.3) (3.4) 14.5 (5.1) 3.4 (5.1) 9.0 16.78

(188.9) (3.5) 16.0 (5.6) 3.5 (5.3) 9.8 18.45

(196.5) (3.7) 16.6 (5.8) 3.7 (5.5) 4.8 13.73

Assumptions: -

-

All items excluding Taxes, Capex and Change in Working Capital were provided in Exhibit 5. I computed Taxes as 35% of EBIT, since we are interested in the unlevered cash flow and therefore we do not consider interest and its deductibility effect which would result in lower taxes. Capital Expenditure – provided in the text that it is expected to grow with 4% per year starting from the value reported in 2007 (3.3 mln). Change In Working Capital – increases in the same proportion with revenues from the level of 2007; please see details below. In my opinion this assumption is not sustainable, since at one point, NWC should revert to 0 instead of becoming more negative year after year.

Working Capital (YE 2007) = Total Current Assets (excl. excess cash) – Total Current Liabilities = (48.07 – 26) - 64.40 = (42.3) Total Revenue chg (%) Net Working Capital chg (%)

74.1 (42.3)

80.8 9.0% (46.1) 9.0%

88.0 9.0% (50.3) 9.0%

96.0 9.0% (54.8) 9.0%

104.6 9.0% (59.8) 9.0%

114.0 9.0% (65.1) 9.0%

124.3 9.0% (71.0) 9.0%

135.5 9.0% (77.4) 9.0%

147.7 9.0% (84.3) 9.0%

160.9 175.4 191.2 208.4 216.8 9.0% 9.0% 9.0% 9.0% 4.0% (91.9) (100.2) (109.2) (119.1) (123.8) 9.0% 9.0% 9.0% 9.0% 4.0%

1b. Net working capital is negative for Tottenham Hotspur. Explain why this is generally the case for football clubs (limit your answer to 1-2 sentences). Since most of the revenue of football clubs comprises attendance, merchandise, sponsorship and broadcast fees which are traditionally paid either up-front at the beginning of the season or on the spot by fans, there is no need to grant credit terms as it is the case in a traditional business. On the other hand, the football club might obtain relaxed credit terms from its suppliers because of its strong cash position which has also an important influence on working capital.

Tottenham Case

Student: Petru-Catalin, David (10824618)

1c. What is Tottenham Hotspur’s expected return on equity? Assume the market risk premium is 5%. For obtaining the expected return on equity, the CAPM should be applied: ERi rf  i (ERm rf) = 4.57% + 1.29 * 5% = 11.02% 1d. What is Tottenham Hotspur’s weighted average cost of capital after tax? First, we have to approximate the cost of debt before tax in order to include it in the WACC formula: Cost of debt = Yearly Interest Expense / Balance of Debt at YE = 2.26 / 43.08 = 5.25% (it would have been more relevant to have the average yearly balance of debt available in the text) WACC = [MVD*(1-t) / (MVD+MVE)*rD]+[MVE/(MVD+MVE)*rE] Finally, we have to estimate the market values of equity and net debt and input them into the formula. 1) The Market value of equity is equal to Tottenham’s market cap at December 31,2007 which can be extracted from exhibit 2 as the difference between EV and Net Debt (MVD). MVE = EV – MVD = 156 – (0.12 * 156) = 137 mln (please note that this value does not reconcile with the market cap provided in exhibit 4 but I believe it to be more accurate) 2) To obtain the market value of net debt (MVD), we deduct the market value of equity from the enterprise value. MVD = EV – E = 156 – 137 = 19 mln Based on the figures above: WACC = [19/(137+19)*5.25%*(1-35%)]+[137/(19+137)*11.02%] = 10.1% 1e. Based on your previous calculations, what is Tottenham Hotspur’s enterprise value? DCF Valuation Year Free Cash Flow Residual Value WACC Discount Factor Discounted Cash Flows Enterprise Value

1 2008 4.98

2 2009 5.81

3 2010 6.70

4 2011 7.68

5 2012 8.72

6 2013 9.84

7 2014 11.06

8 2015 12.35

9 2016 13.73

10 2017 15.21

11 2018 16.78

12 2019 18.45

13 2020 13.73 234.13

0.91 4.53 136.02

0.82 4.79

0.75 5.02

0.68 5.23

0.62 5.39

0.56 5.52

0.51 5.64

0.46 5.72

0.42 5.78

0.38 5.81

0.35 5.82

0.32 5.82

0.29 70.95

10.10%

Details for residual value calculation: I applied the Gordon-Growth Formula for estimating the residual value, assuming that the FCF will grow indefinitely beyond year 13 at 4% per year (in line with the forecasted growth in income and operating expenses, as mentioned in the text).

Tottenham Case

Student: Petru-Catalin, David (10824618)

RV13 = FCF13 * (1+g) / (WACC-g) = (13.73 * 1.04) / (10.1% - 4%) = 234 mln 1f. Based on your previous calculations, what value would you expect for Tottenham Hotspur’s share price? Is the share currently over-/ undervalued? Enterprise Value Less: Interest Bearing Debt Plus:Excess Cash Balance Equals: Estimated Value of Equity Shares Outstanding (mln) Estimated Value per Share Actual Value per Share

136.02 (43.08) 26.00 118.94 9.29 12.80 14.78

Based on my previous calculation, a share of Tottenham is worth 12.80£ compared to its actual market value of 14.78£ making it currently undervalued. In order to compute actual value per share, I once again used the data from exhibit 2 instead of that from exhibit 4): Acual Value per Share = (EV-Net Debt)/No. of shares outstanding = [156 – (0.12 * 156)]/9.29 = 14.78£ 2a. Exhibit 2 shows four variables that can be used to perform a multiples analysis. Which two of these variables are most suitable for analysis? Why are the other variables less suitable for a multiples analysis? The two variables which are most relevant in my opinion are EV and Operating Income. These can be combined into a ratio – EV/Operating Income which can be afterwards used to compare clubs in terms of earnings generating capacity. A low ratio indicates high earnings generating capacity and a high ratio indicates a low generating capacity. The other variables do not offer a complete image regarding the value of the club. Net Debt/EV is an indicator of risk because a club with large debt can pose significant problems for equity holders if adverse scenarios occur whereas the second variable – Revenue is less indicative of the club’s value for a shareholder in comparison to Operating Income. 2b. Would you consider all clubs in Exhibit 2 comparable to Tottenham Hotspur? I would consider the clubs which have similar EV/Operating Income and Net Debt to MVE ratios because these clubs would be comparable with Tottenham in terms of earnings generating capacity and risk (e.g default risk). The clubs which could be considered by applying this criteria would be Liverpool and Newcastle United.

Tottenham Case

Student: Petru-Catalin, David (10824618)

2c. Given your answers in 2a and 2b, perform a multiples analysis using two variables. What is Tottenham Hotspur’s enterprise value according to your multiples analysis? Once again, I will use the Operating Income and EV variables combined into a ratio. Taking into consideration that in my opinion, Liverpool and Newcastle is the only true comparable clubs, we obtain the following results: Team

EV

Net Debt

MVE

Revenue

1

2

3=1-2

4

Manchester United

934

785

149

Arsenal

588

312

276

Chelsea

345

97

248

Liverpool

291

52

239

Newcastle United

167

77

90

Tottenham Hotspur

156

19

137

Everton

106

34

72

Aston Villa

90

14

76

Operating Income 5

169 134 154 123 87 75 58 50

EV/Operating Income 6=1/5

MVE/Revenue

Net Debt/MVE

7=3/4

50 19 11 53 (20) negative income 20 15 6 28 5 31 (8) negative income (11) negative income

0.9 2.1 1.6 1.9 1.0 1.8 1.2 1.5

5.25 1.13 0.39 0.22 0.85 0.14 0.47 0.19

EV =Avg(EV/Operating Income) * Operating Income = 21.5 * 5 = 107.5 mln (value of Tottenham’s EV based on an average of Liverpool’s and Newcastle’s actual EV/Operating Income ratio) 2d. What would you expect the share price of Tottenham Hotspur to be? According to the first measure the market value of equity should be: MVE = EV – Debt + Excess Cash = 107.5 – 43 + 26 = 90.5 mln (or 9.74£ per share) 3a. Using a discounted cash flow analysis, calculate the value from building a new stadium. (Hint: create a table). Assume construction begins in 2008. Project Analysis - New Stadion Year Incremental Attendance Income Incremental Sponsorship Income Total Incremental Revenue Total Incremental Opex Depreciation EBIT Tax (Refund/Expense) Depreciation Capital Expenditure Change in Working Capital Free Cash Flow WACC Discount Factor Discounted Cash Flows NPV

1 2008 (125) (125)

2 2009 (125) (125)

3 2010 9.0 4.1 13.1 (2.6) (25.0) (14.5) 5.1 25.0 15.6

4 2011 9.8 4.4 14.3 (2.7) (25.0) (13.4) 4.7 25.0 16.3

5 2012 10.7 4.8 15.5 (2.8) (25.0) (12.3) 4.3 25.0 17.0

6 2013 11.7 5.3 16.9 (2.9) (25.0) (11.0) 3.8 25.0 17.9

7 2014 12.7 5.7 18.5 (3.0) (25.0) (9.6) 3.3 25.0 18.8

8 2015 13.9 6.3 20.1 (3.1) (25.0) (8.0) 2.8 25.0 19.8

9 2016 15.1 6.8 21.9 (3.3) (25.0) (6.3) 2.2 25.0 20.9

10 2017 16.5 7.4 23.9 (3.4) (25.0) (4.5) 1.6 25.0 22.1

11 2018 18.0 8.1 26.1 (3.5) (25.0) (2.5) 0.9 25.0 23.4

12 2019 19.6 8.8 28.4 (3.7) (25.0) (0.3) 0.1 25.0 24.8

0.91 (113.5) (35.0)

0.82 (103.1)

0.75 11.7

0.68 11.1

0.62 10.5

0.56 10.0

0.51 9.6

0.46 9.2

0.42 8.8

0.38 8.4

0.35 8.1

0.32 7.8

13 13 2020 Residual 20.4 9.2 29.5 (3.8) 25.7 438.6 (9.0) (153.5) 16.7 285.1

10.1% 0.29 4.8

0.29 81.6

Tottenham Case

Student: Petru-Catalin, David (10824618)

Assumptions: -

-

Incremental Attendance Income, Sponsorship Income and Operating Expenses compared to the base case are given in the text. The station is depreciated over 10 years starting from the moment it is finalized. I computed the terminal EBIT using the Gordon Growth formula, assuming a 4% perpetual growth rate, in line with the assumptions in the base case. RV13 = EBIT13 * (1+g) / (WACC-g) = 25.7* (1+4%) / (10.1%-4%) = 438.6 mln I assumed that there will be no incremental Capex and WC investments after the stadion is built. The tax rate considered in the analysis is 35% as given in the text.

Conclusion: -

At the current cost of capital the analysis results in a negative NPV and therefore Tottenham should not make the investment in a new stadion. However, the NPV might turn positive if the project gets another financing mix – preponderantly debt financing which not only has a lower required return that equity capital but which also benefits from tax deductions on interest.

3b. How is the decision to hire a new player affected by the purchase of the new stadium (answer qualitatively, no calculation required. Use the term ‘project externality’ in your answer). Even though to the analysis above shows that investing in a new stadion at this point is not a wise decision, a valuable project externality resulted from building the arena would be for sure an increase of the visibility of the club between players, coaches and football fans. This would probably also result in a stronger position of the club in the transfer market and as a consequence the chances of attracting and signing talented players will also increase.