“How does it feel to have a trillion dollars burning a hole in your pocket?” Andrew Blackman, the Wall Street Journal
Not since the conquistadors discovered Potosí, Bolivia’s famed silver-ore mountain and “Cerro Rico”, has anyone known the answer to the question Blackman rhetorically posed this week. But with the data-cruncher Prequin estimating that private-equity firms now hold $1.141 trillion in investible funds, the managed-investment arm of the financial-services industry seems to have a fair idea.
This so-called “dry powder” is all down to the likes of pension funds and insurance firms ploughing ever more cash into the sector: $431 billion of it in 2013 according to Prequin. “Private equity has been the best-performing asset class for many institutional investors over the long term,” Blackman quoted Hugh MacArthur, the head of global private equity at the consulting firm Bain & Co, saying. “They’re saying they need to continue to pursue those returns, so they’re putting more money into private equity.”
That is all very well but just as a footballer in demand by a number of the wealthiest clubs commands a premium – perhaps even exaggerated – price, so too do general assets when there is a wall of money chasing them. Stockmarkets are at all time highs, ditto real estate and government bonds in many developed countries, and the undervalued, growth assets that offer a strong long-term view and an opportunity to pare back costs of the kind favoured by private-equity firms seem few and far between.
It has caused some to turn their attentions to unorthodox investments, and there are signs that in time football clubs could be among the beneficiaries. In January this year Hertha Berlin announced it had received a €60m investment from the US private-equity firm KKR. The cash represents a minuscule fraction of its $102.3 billion of assets under management (less than 0.006% in fact), so KKR could well afford its purchase and a lot more investment in the club besides. Although perhaps Hertha did not prosper on the field in their first six months of what is said to be a minimum-seven-year arrangement under KKR’s part ownership, slipping as they did from seventh to 11th in the Bundesliga, the transaction was a vote of confidence in the football sector in general and an under-performing club in the German league in particular.
Football clubs have long been seen as trophy assets for wealthy investors. But KKR’s rationale is very different. Although its cash has for the moment bought only 10% of the Hertha’s shares with voting rights (later convertible into a third of them, should KKR see fit), it aims to improve the club’s financial outlook over time so that the equity bought is worth considerably more. Hertha’s indebtedness has been refinanced on more affordable terms and KKR’s money has also allowed onerous TV and catering contracts to be bought out, improving the cash-flow position.
The club does not own its own stadium, which is leased from the local authority. This eliminates the fast-buck route many private-equity firms use to return capital to investors: borrowing against unleveraged assets to release funds. As already mentioned, private equity has a reputation for paring back costs, often by dropping or spinning off non-core operations and sacking staff seen as extraneous to the business or too expensive. But with Hertha paying less than half their revenues out in wages and salaries, which is a pretty lean expense ratio for a football club, that opportunity also looks limited.
So what was KKR looking for? What, in essence, are the lessons for football club owners who want to come by the private-equity windfall Hertha Berlin have enjoyed? “First of all we didn’t look at it as a trophy investment,” Tim Caflisch of KKR told me. “The days of the owner taking on a club as a hobby and running losses forever are not possible any more because of changes in the way leagues are now regulated, such as with Financial Fair Play.
“We wanted something that offered growth and would be sustainably profitable. We looked across Europe for cities with massive potential as media markets and a football club that was not already dominant: Berlin and Hertha were the natural outliers.”
Hertha’s underperformance is clear. Relegated twice in the past five years and with a stadium operating at two-thirds capacity across the season, there is the potential for “huge incremental revenue at no big cost”. This is particularly the case in the Bundesliga, where central-broadcasting payments are weighted according to a club’s league performance over the prior five-year period, placing Hertha 16th in the broadcast-revenue rankings. Finish among Germany’s top-10 clubs each year and that source of income improves markedly.
KKR were also well placed to sniff the wind for future trends. As a long-term shareholder in the German satellite broadcaster ProSieben (although earlier this year it said it would sell its stake) it knows the value in store for rightsholders. And with the next international media-rights deal for the Bundesliga estimated to rise by some 80%, how this will improve the club’s cash-flow picture seems clear. “Football is globally appealing and live media rights are one of the only really must-have assets for pay-tv,” added Caflisch. “This is why there is such incredible growth in so many markets, well above the GDP growth trend.”
Underperformance on the pitch also shrinks sponsorship revenues, so there should be obvious opportunities for Hertha to raise more money from the commercial segment if the standard of the football improves. Then there is the cost effectiveness of the club. It has 12 city-centre training pitches and a good record in youth development: the Boateng brothers and the US’s World Cup goalscorer this week John Brooks Junior all came through the ranks in Berlin. KKR saw this as another box ticked.
Owners who regard themselves as vendors of their clubs might not feel compelled to finance expensive academy structures – investments that on the face of it will take years to mature. Paradoxically, though, the Hertha experience shows this is one of the areas the smart money will look for when it considers where to buy in to football.
Another is in keeping costs low, which provides markers for Premier League clubs. “Germany is the healthiest league in terms of profitability,” said Caflisch. “England is the leader in revenue generation but also in spending. German clubs don’t spend fortunes on transfers. The Bundesliga has sustainably profitable clubs.”
So there is private equity’s shopping list: a club that can keep a lid on its wage expenditure, offers growth in gate, media and/or commercial income and has a strong youth infrastructure. All of those things are hard to achieve at once. But for the executive teams that do, there is a chance to tap in to private equity’s 21st Century Potosí and the trillion-dollar seam that lies within.
Journalist and broadcaster Matt Scott wrote the Digger column for The Guardian newspaper for five years and is now a columnist for Insideworldfootball. Contact him at moc.l1713458124labto1713458124ofdlr1713458124owedi1713458124sni@t1713458124tocs.1713458124ttam1713458124.