Business analysis and valuation of Manchester United, Inc
1.0 Problem Statement
Manchester United Plc is a UK based incorporated company operating in the recreation and leisure industry as a professional football club. The company engages in the management of the club activities including sponsorship, marketing, the media network, foundation, fan base, sports features and news. Further, the company engages in marketing and selling of Manchester United branded consumer products such as sports wears, coffee mugs and bedding spreads, in addition to the distribution of media content and broadcasting rights related to live football matches through their commercial partners and own television channel (MUTV); as well as operating the Old Trafford Sporting arena. The company is listed on the New York Stock Exchange market, where it trades its securities (Class A ordinary shares and Class B ordinary shares). As of June 10th 2020; the company’s shares were trading at $16.52 per share. As at the date, the company was valued at a market capitalization of $2.719 billion (Yahoo Finance, 2020). This evaluation project seeks to determine the share valuation of Manchester United plc by the end of 2020 with use of discounted valuation models; from which an investment recommendation will be provided based the difference in the share prices. The paper is structured in five parts, including introduction, background information, theoretical framework, designs and methods, data analysis and work plan.
2.0 Background Information
The evaluation of Manchester United Plc’s target share prices will be based on discounted cash flow techniques which will be applied on five years period financial reports of the company. To ascertain the present value of the five years future cash flows, the present values of the five years’ free cash flows will be discounted to the current year. The critical assumption in this analysis is that there will be stable growth in cash flows based on historical trend, holding that the company’s capital structure will be constant throughout the period. In reality, however, companies are usually subjected to various conditions, which affect the companies in multiple ways and such, the assumptions made may not hold, as well as forecasted cash flows change. In this section, we discuss the environmental factors which are potential to affect the valuation of Manchester United Plc’s share prices. The environmental factors are classified as either macroeconomic or industry-specific factors.
2.1 Macroeconomic environment
It is essential to understand how economic factors affect the business to make smart investment decisions and grow the company’s performance to greater heights (Bush, 2016), and this starts from having an understanding of how external environmental factors influence business operations and decisions. Macroeconomic environmental factors affect the entire country’s economy or the industry at large, which a company has no power nor ability to control their occurrence. While some factors may be favourable to the company, others cause adverse effects to the company. Over recent years, there have been a lot of changes in the macroeconomic environment, especially in the UK, which is Manchester United Plc’s primary market. This study adopts the PEST analysis to examine the environment.
Political environment
In PEST analysis, the first component is the political environment. The UK business over the recent past has been affected by political issues such as the Brexit deal, which according to Financial Time (2020), rattled the UK markets, causing a political risk to businesses, as asserted by financial analysts. However, UK’s favourable political environment is commendable for the prosperity of many businesses. While the political environment is not limited to political stability alone, but the UK has also put in place governance structures that ensure the government provide the necessary infrastructure, systems and policies to favour businesses. Manchester United, being an operator in the leisure industry could suffer a great deal in case of possible political instability, whose consequences could include the closure of football matches, which is the key activity of the company.
Economic environment
Economically, the current global COVID-19 pandemic has caused a worldwide economic crisis resulting in recession in most economies. Recent studies which have examined the economic effects of the pandemic have universally reported a decline in economic growth as measured by reduced economic activities. While most companies all over the world suffered financial pinch, as attributed to lower sales turnover, reduced demand for products and services due to the lockdown measures taken to combat the crisis, companies operating in the leisure and recreation industry suffered the most. The UK was among the worst affected countries, with the lockdown effects resulting in the suspension of all football matches. During the period, Manchester United Plc lost a massive pull of revenue, which otherwise could have been earned from live games broadcasting as well as ground entry ticketing. The share prices of the company reduced, consequently (figure 2). Reuter on 21st May 2020 reported the company to have withdrawn its 2020 financial forecast due to football suspension in the UK which had caused a significant decrease in earnings.
With the resumption of the football matches, it is expected that the company’s cash flows will increase. However, at a lower rate, until the entire world economy will resume normalcy through gradual recovery.
Figure 1: 6 months share price graph
Source: Manchester United Plc investor relations website. https://ir.manutd.com/stock-information/stock-chart.aspx
While the UK is still recovering from the economic effects resulted by Brexit exit, being among European countries with the highest GDP in the world confirms the favourable economic environment in which Manchester United Plc majorly operates.
Technological environment
Technology has taken pace on influencing the companies’ operations all over the world. While companies are striving to gain competitive advantage by adjusting accordingly to technological advancement, it is a much-affecting factor, especially to Manchester United Plc. The provision of services and goods by the company majorly relies on the use of technology, including the broadcasting of matches to retailing of branded consumer products which are mostly purchased through online platforms. For the company to keep pace and remain competitive in the market, as well as acquire a higher market return in the form of an increased number of consumers, there is need for having current levels of technology to ensure efficient content delivery to gain competitive advantage. Companies in the leisure industry need to maintain up-to-date technology to support ticketing and reservations.
2.2 Industry Environment
Location
Manchester United Plc operates in the leisure and recreational industry, based in the United Kingdom, Europe. It is headquartered in Stretford, UK. The main activities of the company, which involve professional football are based in Europe, with the club playing its domestic matches in Old Trafford as their sporting arena in the UK as well as other games in other parts of Europe.
Competitors
Competition is mandatory in every industry. Manchester United is subjected to market competition from Barstool Sports, Vavi Sports and Social Club, Celtic and Goals companies. Barstool Sports is a US-based private company which majors in digital sports, entertainment and media brand that delivers content across multiple platforms. Vavi Sport and Social Club is a US-based private company which provides sporting and social events and fitness training services. The Celtic company manages a football club in Scotland while Goals company is a soccer centre in the soccer market-based in Aberdeen.
In efforts to maximize revenue through the use of fan base, the company competes with other major clubs in the English Premier League as well as in Europe including Arsenal, Manchester City, Chelsea, Liverpool, Juventus, As Roma, Celtic, Real Madrid among others.
Company model
The company’s business model is in the form of a single entity in three sectors; commercial, broadcasting and matchday. These sectors are the main drivers of the company’s cash flows which in turn affect share prices. The sporting industry in the UK has had a significant setback since early 2020 after the covid 19 outbreak. The company’s earnings through matchday were halted, with a substantial effect on broadcasting revenue. The only operating sector which earned the company revenue during the period was in form of retail merchandising and sponsorship. The leisure industry in which Manchester United Plc operates, is hypersensitive to various macro and microeconomic changes including regulations, economic, political and socio-cultural. The sector suffered a significant setback after the restriction of movements in Europe which implied cancelled business trips and sporting activities.
The company’s SWOT analysis reveals among its strengths include the existence of a strong brand which is widely recognized. The company also has a broad fan base of over 1 billion worldwide as well as an extensive portfolio of sponsors. Brand superiority greatly influences the company’s cash flows through increased tickets revenue, increased commercial revenue through retail of merchandise and sponsorship. However, the company’s income fluctuates with much reliance on sporting activities, such that there is high-risk congruence between the company’s cash flows to football in Europe. For instance, football break in the mid-2020 season revealed the weaknesses due to the revenues lost. It is expected that the company’s earnings in the 2020 financial year will reduce drastically as compared to 2019.
3.0 Theoretical Framework, Designs and Methods
3.1 Data
According to Manchester United Plc (2019) financial report, the company prepares it financial statements in accordance with IFRS. The study will be guided by the business valuation models by Palepu and Healy (1996) alongside its IFRS edition with the 5th edition of 2012. The financial information for analysis and valuation will be obtained from the company’s 2019 financial report, Bloomberg and Yahoo finance. Yahoo finance will provide historical information regarding the company’s share prices and market statistics, including market capitalization, the company’s beta coefficient and past valuation measures. Bloomberg will be used to obtain additional statistics and company information relevant in the study. Bloomberg terminal will be used to obtain financial data that will aid industry comparison as well as the analysts’ reports and recommendations published on the terminal. Supporting information and news potential to affect the company’s share prices will be obtained from online trusted sources such as financial times, Reuters and Guardian.
Forecasted cash flows will be determined from the analysis of Manchester United’s historical financial reports (ten years) from 2009 to 2019. The forecasted cash flows will be discounted to 2020 using discounted valuation techniques to determine the company’s present value.
3.2 Valuation models
3.2.1 Absolute valuation models
These are discounted cash flow techniques. They are based on the basic valuation model, which asserts that the value of an asset is the present value of its expected cash flows.
The dividend discount model (DDM)
According to this model, the value of a share is the present value of all future dividends to be received from the company.
Vs = + + + …. +
Where Vj represents the share price; Dn represents dividends receivable in year n; k represents the costs of capital, or required rate of return and n represents year period. Discounting for an unknown period, we may use the formula:
Vs =
The use the dividend discount model requires first to obtain a forecast of future dividends as well and the possible selling price of the share at the period end. This method, however, may be infeasible due to changes in the growth rate of the company’s earnings. Therefore, dividends may change instead of being constant as it is assumed by the model. There is a need for the estimation of growth rate. Using this module assumes that dividends will grow at a constant rate and that the discount rate will be greater than the growth rate.
Free Cash Flow to Equity Model
Free cash flows are the earnings to the company after the debts have been paid and return attributable and providing for the required income for maintenance of the company’s asset base. This model assumes that the company will continue generating cash flows back to business, which is much more worth today than the company’s current share prices. Free cash flow to equity technique uses present value concept by utilizing the cost outlay required and for the growing firm and working capital changes required for the growing company. The free cash flow is obtained by adding back depreciation expense and new debts issue to net income less the capital expenditures, working capital changes and principal debt repayments. The model determines cash flow available to the shareholders remaining after settlement of dues to external providers of capital and provision for the continued growth of the firm. Once the expected free cash flows to equity are obtained, they are discounted to obtain the value of the company’s share.
Vs =
The free cash flow to equity are determined from the operating cash flows after accounting for debts and interests and includes dividends paid to the shareholders.
Free Cash Flow to Firm (FCFF) Model
This model determines the price of a share and the value of the company. The firm’s equity value is obtained by deducting the firm’s value of debt from the total value of the firm. The firm’s operating cash flows are discounted at the firm’s weighted average cost of capital instead of cost of equity. The operating free cash flow or free cash flow to the firm (FCFF) is obtained by the formula:
Earnings Before Interest and Tax (1 – Tax Rate) + Depreciation Expense – Capital Expenditures – change in Working Capital – Change in other assets
This is the cash flow generated by a company’s operations and available to all providers of capital to the company, both equity and debt. If there is expected constant growth of the firm’s earnings, then the model is reduced to provide the value of the firm using the formula:
Value =
To use the absolute valuation models parameters used are determined as follows:
Working capital changes is the difference between the company’s liquid assets and current liabilities, which enables the company to meet day to day operating needs and settle short term obligations as and when they fall due. The value of the working capital changes will be obtained from the company’s balance sheet by deducting current liabilities (trade payables and accruals) from current assets (trade receivables, inventory and cash equivalents). Earnings before interest and tax used in the is generated by the sales of good and services and subtracted by the costs of goods sold (COGS) and the other operating expenses. These will be obtained from the company’s income statement. The capital expenditure and depreciation represents the payments to purchase non- current assets such as machinery, equipment, vehicles or tools to improve the operation. The capital expenditure will be obtained from the company’s statement of cash flows under investing activities.
Effective tax rate is the prevailing rate of tax payable to the government. Tax rates are applied to the net income to ascertain tax liability expense due from the company. Other tax rates may be imposed on capital gains made, dividends, pay as you earn paid to employees, among other forms. As from 1st April 2020, the applicable corporation tax rate in the UK is 18%. The company’s weighted average cost of capital represents the company’s cost of capital on all capital components, including the cost of equity, cost of debentures, cost of preference shares and cost of loans. It is a measure of the minimum required rate of return to the company for the risk taken. The WACC will be obtained by the formula:
WACC = Ke( )+ Kp () + Kd () (1 – T)
Where V is the total market value of the firm (equity + preference shares + debt); E, P and D represents the market values of equity, preference shares and debts respectively; Ke, Kp, and Kd represents the percentage cost of equity, preference share and debt respectively while T represents the tax rate. The market value of Manchester United Plc will be obtained from Yahoo Finance website represented by market capitalization. The cost of equity shall be determined using the capital asset pricing model (CAPM) using the formula;
Ke = Rf – β (Rm – Rf)
Where Rf represents the return on risk-free investment, Rm represents market return while β represents the company’s beta coefficient. According to the portfolio theory, the beta coefficient is the measure of the company’s systematic risk, as measured by the company’s volatility to changes in the market risk. Higher beta above market beta (1.0) indicates higher company risk while a lower beta of less than one represents less investment risk than the market risk. The beta coefficient of the company will be obtained from yahoo finance. Currently, according to yahoo finance (2020), Manchester United plc has a beta of 0.84, representing a lower risk compared to the market risk.
The estimates of risk-free rate of return and growth rate will be based on the IMF’s estimates for the UK. IMF estimates UK’s growth rate from 2022 to 2024 to be 1.6%. however, considering the economic impact brought by the COVID- 19 pandemic, there will be need to reconsider the estimate as the growth rate will presumably reduce due to reduced economic activities during the lockdown. The cost of preference shares is obtained by dividing the company’s dividends on preference shares by the market price per preference share. The cost of debt will be computed using the formula:
Kd =
Where I represent the interest payable on debts, T is the tax rate; M is the maturity value of the debenture, P is the par value while N is the maturity period in years.
3.2.2 Relative valuation models
Relative valuation models compare the company’s value to that of its competitor to determine the company’s value. They are alternative absolute value models that ascertain the company’s valuation based on estimated future free cash flows estimated to the base period (2019). Relative valuation models include price to earnings ratio, price to book ratio, price to cash flow ratio and economic value added. This study will, however, utilize the absolute valuation models.
References
Bush, T. May 2016. An Example PEST Analysis of The UK. https://pestleanalysis.com/pest-analysis-of-the-uk/
Financial Times, June 2020. Analysis of political risk and Investment: Brexit is back to rattle UK markets. https://www.ft.com/content/203cee7c-1b14-4860-8d12-b21e41c06154
Palepu, K. G., Healy, P. M. & Peek, E., 2013. Business Analysis and Valuation – IFRS Edition. Third ed. Hampshire, United Kingdom: Cengage Learning EMEA.
Reauters June, 2020. Manchester United withdraws 2020 forecast as soccer put on hold. http://feeds.reuters.com/~r/reuters/companyNews/~3/Mm6Gt1Gjkzw/manchester-united-withdraws-2020-forecast-as-soccer-put-on-hold-idUSL8N2D333V