October 23, 2021

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The question of that profit-boosting Juventus and Barcelona swap deal

It’s been a bad week for FC Barcelona. Talisman, and notorious bad dresser, Lionel Messi has departed the Blaugrana due to “financial and structural obstacles” imposed on the club by La Liga. It’s a devastating blow not just for the club, but for the league and its television rights owners. Particularly ESPN who just signed a $1.4bn deal to broadcast Spanish football to 2029, presumably under the assumption Messi would pull the punters in. Ooops.

Barcelona’s finances have been a disaster in slow motion for a few years now, so it was always touch and go as to whether they could afford to renew Messi’s reportedly several hundred million euro contract.

The story of this financial deterioration was expertly told by the FT’s Simon Kuper in an aptly timed long read last week. Yet, two paragraphs in particular sparked a debate in the FT Alphaville Slack chat.

Here’s the section in question:

By summer 2020, Barça’s transfer deficit was haunting Bartomeu and his board members. Under the rules that govern Spanish member-owned clubs such as Barça, directors had to repay losses out of their own pockets. The board needed to book profits urgently before the financial year ended on July 1. And so a bizarre swap transfer was concocted. The counterparty was Juventus, also eager to improve its books. Juve “sold” Bosnian midfielder Miralem Pjanic to Barça for a basic fee of €60m, while Barça sold Brazilian midfielder Arthur Melo to Juve for a basic €72m.

These sums would never actually be paid. They were invented for accounting purposes. Under bookkeeping rules, each club could book its handsome supposed selling price as immediate income. The notional payments would be spread out over the years of the players’ contracts. Only €12m in actual money would end up changing hands, the difference between the two players’ fictional prices, paid by Juve to Barça. What mattered was that the swap helped both giants clean up their books.

Some Alphavillains questioned whether this deal was entirely above board, particularly if the effect was to help Barça’s directors avoid reaching into their own pockets.

Now, FT Alphaville has no deep insight into the reason behind these transfers. We’ll leave the machinations of that to Simon. But it’s important to note here that what is described is, under accounting rules, legitimate. Despite arguably appearing questionable.

Let us explain.

Oddly, football players — or, to be accurate, their registration rights — are intangible assets. Yes, Cristiano Ronaldo is accounted for like software development costs.

So what does that mean in practice? Well, imagine two football clubs: ES Alphaville, and Davos FC.

ES Alphaville buys a player from Davos FC for £10m who has climbed through the ranks from youth team football, just like a young future global soccer leader should.

At the same time ES Alphaville sells a player to Davos FC for £20m who has been at the club for 3-years, with 2-years remaining on her contract. She was originally bought for £10m.

The net effect is ES Alphaville receives £10m in cash. Easy enough so far.

Now this is where it gets a little trickier. For the buying club, the acquisition of the player isn’t immediately recorded as a cost on the profit and loss statement. As say, trading gains (or losses) on oil hedges might be for an airliner like easyJet.

Instead, because the player is an asset whose economic value (playing football for the club) will be spread over the term of her contract, the buyer capitalises the cost before amortising the price over the contract period.

So, in this case, for their respective purchases both clubs will record a cash outflow through the cash flow from investing statement, not the profit and loss statement.

In our example: £10m of cash out for ES Alphaville, and £20m for Davos FC. For simplicity’s sake, let’s just say these are the only transfers made by the respective clubs over the period.

However, both clubs have also received a transfer fee. This cash inflow will also be recorded on the cash flow from investing statement:

Now you might notice we haven’t discussed losses or gains so far, just movements in cash. So what do these transfers mean for the profit and loss statement?

Well, as any asset with a useful life, most football players have book values. This book value, recorded on the balance sheet, is the original cost of the player minus the accumulated amortisation. Remember the player Davos FC purchased off ES Alphaville for £20m was originally bought for £10m on 5-year contract with 2-years remaining?

So her net book value on ES Alphaville’s balance sheet will now be just £4m (the £10m initial cost, minus 3-years of amortisation at £2m per year).

The £10m player ES Alphaville purchased? Well she was a youth player. So there is no original cost of acquisition, and therefore no book value.

This is crucial as the gain booked through the profit and loss statement on a player sale is the difference between the player’s residual book value, and the transfer fee.

For a real life example, take a look at Juventus’ transfer breakdown in its 2020 annual report.

Moise Kean, a youth player, was sold to Everton €27m. So the capital gains were €27m. Marauding full-back João Cancelo, meanwhile, was sold to Manchester City for €65m but, as his book value €32m, the capital gain was the difference: €30.4m.

(The smaller gain is explained by an extra fee clubs are required to pay to the clubs who originally trained the player in their youth. More here. Plus, the net present value of the transfer fee being a touch lower than the full €65m.)

Here’s how that looks in Juventus’ books, with the key parts underlined:

So, in our example, ES Alphaville can only book £16m of revenue (£20m of capital gains from the transfer fee, minus the £4m residual book value), while Davos FC can record the whole £10m.

In theory, these gains can flow straight through to each clubs’ bottom line. But in reality, there are costs associated with transfers that have to be deducted from the revenue. While agents’ fees are capitalised and amortised, others costs such as a golden handshake are expensed. Still, these costs rarely add up to a figure anywhere near the transfer fee. For our example, let’s say they’re 10 per cent of the total consideration.

Here’s how that would look in the profit and loss statement:

There’s one final box to tick here, what happens to each clubs’ cash flow from operations.

While some clubs seemingly specialise in developing youth players and then selling them for handsome fees to the elite clubs (Sevilla, Southampton and Boca Juniors spring to mind), transfer dealings are not technically part of a club’s day-to-day operations. Think again of our airline and oil hedging example.

So any capital gains or losses from transfers are removed from the cash flow from operations table so investors can get a clearer picture on how the core business of TV rights, ticket sales and shilling overpriced merch is doing. The gains or losses are then, as discussed above, re-included in the cash flow from investing table.

Here’s how that looks in reality, with Juventus’ 2020 cash flow statement (with our underlining):

So, there you have it. Fees from player sales, minus the book value, are capital gains that run through the profit and loss statement, helping to boost profits. While buying players is treated as investment, so the player is initially capitalised and then amortised over the period of their contract.

Now, many will quibble with the fees paid in the case of the Pjanic/ Melo transfers. Particularly as Pjanic barely got a kick for Barcelona last season, and Melo has failed to prove a hit with the Old Lady.

But, hindsight is 20:20. From Ousmane Dembele’s €105m move to Barcelona, to Denilson’s blockbuster transfer to Real Betis in 1998, the history of football is littered with mega money deals turned sour. On the same point, proving that a player was paid for an inflated fee to boost net income is tough. Some players seem expensive, and turn out to be cheap. Others, like Newcastle’s Brazilian barn-door missing specialist Joelinton, the opposite.

Even if a player was sold at an inflated fee to engineer a profit, how to prove it? Unlike an acquired business or brand, a player is not a cash-generating asset that can be tested every year to see if it is living up to the acquirer’s forecasts. Even if they play terribly for the first few seasons, who is to say they won’t eventually come good? Yet the timing of the Melo/Pjanic deals, a day before the end of both clubs’ financial year on June 30, also raises questions.

Anyway, we hope this explainer was helpful. And for those who knew all of this already, do let us know your favourite football transfer flop in the comments.

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