Why on earth buy a football club?

Newcastle United's St James' Park stadium

The quip goes that it is relatively easy to take out £1m by being the owner of a football club. All you have to do is first put in £2m.

Since the English Premier League was formed in 1992, football finances have boomed to the extent that £1m is now small change. However, it is still the case that buying a football club is unlikely to yield much of a return. Despite the significant TV and other commercial revenues, football clubs in England's top flight still struggle to break even. This is ironic, given the goal of setting up the Premier League was to stabilise club finances.

According to the latest Deloitte Annual Review of Football Finance, only half the clubs in the Premier League made an operating profit in the last football season 2012-13 (that is, profits not including net transfer expenditure).

Overall, operating profits for the 20 Premier League teams were just 4% of revenues, and when the net costs of player trading are added, there are large overall net losses.

In the lower divisions where revenues are a fraction of that of the Premier League, the situation is not pretty. In the Championship, which is the second tier of football in England, only three clubs made an operating profit last season and only five made a net profit once player trades are taken into account.

These figures belie the fact that most of England's largest football clubs are run by successful businessmen who make plenty of money in other walks of life.

Furthermore, English clubs are in high demand from foreign investors, with 11 of the 20 Premier League teams currently owned by foreigners. And 13 out of the 24 teams in the Championship are also foreign-owned.

So, given the appalling financial returns, why do people buy football clubs?

Heart over head

One explanation is that it has nothing to do with money. Mike Ashley, the chairman of Newcastle United and proprietor of Sports Direct, does not appear concerned by the fact that he is unlikely to get back the £200m he has loaned to the club. He is, after all, a supporter.

Simon Jordan, in his recent autobiography, tells the story of how owning a football club can go terribly wrong.

Jordan amassed a fortune of £75m in the early days of the mobile phone revolution. In 2000, he paid £10m to take control of South London football team Crystal Palace, becoming the youngest football club chairman at the age of 32.

He was warned by many not to do it, but having watched the club since his childhood, could not resist. Fast-forward 10 years and the club was in administration and Jordan's personal wealth largely wiped out.

Even though Jordan states he tried to run the club as a hard-headed business, ambition was irresistible and in football, success comes at a high price.

Many owners are simply fans of the clubs they own or have strong ties to the local community. While in the business world, the head can rule the heart, it can be the opposite when it comes to football.

Making a mark

But this does not explain why so many foreigners, without a sentimental attachment to a particular club, are literally queuing up to buy them.

It is reported that Roman Abramovich, the Russian owner of Chelsea, has written off more than £1bn he ploughed into the club since acquiring it in 2003. Catching him up fast is Sheikh Mansour from Abu Dhabi, who has invested close to £1bn in Manchester City since 2008.

Most of the serious money flowing into football recently has come from the Middle East. The Qatar Investment Authority (the country's sovereign wealth fund) bought the French Ligue 1 side Paris St Germain in 2011 and has gone about transforming them in the same way Sheikh Mansour has Manchester City.

According to Deloitte, seven of the 20 largest football clubs in the world by revenue are sponsored by Middle East airlines including Barclelona (Qatar Airlines), Real Madrid, Paris St Germain, Arsenal, AC Milan (all Fly Emirates) and Manchester City (Etihad).

In fact, when Manchester City recently played Arsenal the game was described as Abu Dhabi (Etihad) v Dubai (Fly Emirates).

After all, Dubai, Abu Dhabi, Qatar and Bahrain are all small but rich Gulf states with global ambitions. Football is seen as an important way of expanding their brands, but of course they are also in competition with each other.

Some have suggested that football is simply being used as a geopolitical tool, with many of these investments ultimately government-backed through sovereign wealth funds.

Even though Qatar has no football history or infrastructure, it won the right to host the 2022 World Cup and will lavish a huge budget on the tournament.

Measured by GDP per head, Qatar is the richest nation on earth, but is small, has substantial oil reserves and happens to be situated in a relatively unstable part of the world. By using football, they are putting themselves on the map and even adding a bit more security.

A similar argument might explain why rich individuals buy football clubs. Chelsea Football Club has cost Roman Abramovich a lot of money, but at the same time has made him into a highly recognisable figure around the world.

In recent years, the life of a Russian oligarch could be described as precarious. It goes to show that being successful in business doesn't necessarily make you well-known - but buying a football club can give you celebrity, notoriety and access to important people.

Making money and cutting costs

The accounts do not make for good reading, but on the face of it, there is little reason why football clubs cannot be profitable. In England, Premier League clubs are proverbial cash cows with three strong sources of revenue - TV money, commercial activities and gate receipts.

The Glazer Family bought Manchester United in 2006, recognising the immense value of its global brand as a cash generator and the opportunities to enhance it even further.

The cost of buying the club was loaded on to the club itself, with the revenues it generates used to pay down the debt and interest that the Glazers undertook to buy the club. Eventually, the hope is that the club will essentially pay for itself leaving its American owners in possession of a multi-billion pound asset.

It is rumoured that Arsenal, the North London football club, has substantial cash reserves of over £120m. In this case, the American Stan Kroenke, who owns about 63% of the shares in the club, could award himself a nice dividend if so desired.

Dividends are not the only way to make money from football clubs. When it was speculated that a Middle East consortium was willing to pay £1.5bn for Arsenal Football Club, Kroenke would have made a capital gain of £400m on his shares.

Therefore, growing revenues could increase the value of a club just like any other business. In the English Premier League, commercial revenues have grown strongly in recent years, as clubs look to cash in on the worldwide popularity of the competition.

Sponsorship deals now extend beyond the typical areas of shirts and kit manufacturers to areas such as stadium naming rights.

Not all the commercialisation is popular with supporters. Newcastle United's passionate following was probably not too happy when their home ground since 1892 changed its name from St. James' Park to the Sports Direct Arena. The venue has since reverted to its former name.

Vincent Tan, the Malaysian owner of Cardiff City, has caused a bit of outrage with his new branding for the club. The traditional blue strip was changed to red, and the club emblem changed from a bluebird to a dragon. The justification is to improve the marketability of the club in Asia.

Ditto the Hull City fans, who next year may be supporters of Hull Tigers.

The main reason English Premier League clubs fail to make profits, though, is due to strong growth in wages. Last season, the average ratio of the wage bill to turnover was 70%.

Since the inception of the Premier League more than 20 years ago, 80% of the increase in revenues has flowed into wages. Deloitte argues that controlling wage costs are the key to financial stability in football. But given the huge scale of club revenues, a moderate amount of cost control could make clubs quite profitable.

Playing the lottery

The financial gulf between the English Premier League and the Championship is huge. The new TV deal that came into force this year will widen the gap further.

The three season deal between BSkyB and BT Sports is worth over £3bn, a whopping increase of 70% on the previous three-season contract held between BSkyB and ESPN.

Last season, the club finishing bottom of the Premier League had to make do with £39m in TV money. This year, under the new deal, it will be £63m. This is more than Manchester United received from winning the league last year, although this year's victors will see their TV bonanza come close to £100m.

The Premier League makes solidarity payments to clubs in the lower divisions, but these are paltry in comparison. Championship clubs will receive £2.3m each, whereas those in the third and fourth tiers each receive only £360,000 and £240,000 respectively.

Since the collapse of ITV Digital in 2002, the TV contract for lower tier clubs has been almost negligible.

Because revenues are so much lower, the strains on club finances are much harsher. Last season, the average ratio of wage bill to turnover was 90% for Championship clubs.

The gap in funding makes promotion from the Championship to the Premier League a huge financial deal. As a result, the Championship playoff game, a cup final of sorts where the winner gets promoted, is regarded as the most lucrative in football - worth £120m in TV money alone.

This is because even if the club only spends one season in the Premier League (picking up a minimum of around £60m), it will also receive £60m over the next four seasons in parachute payments to cushion the financial cost of relegation.

This is a unique situation in the European football leagues. It is true the overall pot of TV money is greatest in the English Premier League, but importantly, it is more equitably distributed.

The collective rights agreement between all the clubs means that clubs who finish towards the bottom of the league will be assured of a good share of the money.

In other European leagues, TV rights are often negotiated on an individual club rather than a collective basis. This means that TV money is concentrated in the hands of the best supported clubs.

For instance, in Spain, Barcelona and Real Madrid account for about 60% of the total. Likewise, in Italy, AC Milan and Juventus do very well relative to the rest.

This might explain why there has been so much interest in Championship clubs. Any team getting promoted to the Premier League enjoys a huge financial windfall. Buying a Championship club is therefore like taking a punt on property in an up-and-coming part of town.

Leeds United have a illustrious past and a strong fan base, being the only club in the city. They are currently subject to a takeover bid from the Italian "King of Corn", Massimo Cellino. The ambition will be to gain promotion as soon as possible.

Reading are also a club up for sale. In recent years, they have won the Championship twice and made the playoffs on two other occasions so are viewed as a team that can challenge for promotion. Likewise, they sit in an affluent and growing part of the South East with few local rivals. It is not surprising there is reported interest from US, Omani and Indian investors.

But if promotion from the Championship to the Premier League is like winning the lottery, relegation in the opposite direction is viewed as a disaster. Even despite the parachute payments, relegated teams tend to lose their better players, suffer a drop in morale and rarely bounce back immediately.

This year, the relegation battle is a tight affair - and club owners panicked by the drop have been jettisoning managers left right and centre. In the bottom half of the league, six clubs have changed manager this season, with Fulham changing manager twice.

So, who buys a football club?

Sir John Madejski, the current chairman of Reading Football Club, describes the ideal football club owner as having deep pockets, mercurial, and not faint-hearted.

For more, watch Talking Business with Linda Yueh this weekend: bbc.co.uk/talkingbusiness and catch Business Daily on the World Service on 5 March.