Wall Street Introduces Financial Engineering to the World of English Football

Wall Street has always been known for pushing boundaries and breaking rules in the realm of finance.

From mortgage-backed securities to credit risk, financial engineering has been applied to a range of products. Now, football is the latest industry to experience the impact of Wall Street’s tactics. In May of last year, a US consortium, led by Clearlake Capital, acquired Chelsea Football Club for a staggering £2.5 billion ($3 billion). Since then, coowner Todd Boehly has been spearheading a campaign to outbid competitors for high-profile players. This season alone, the club has spent nearly £600 million, an amount that surpasses the total spent by the French, Spanish, German, and Italian leagues combined during the recent January transfer window.

It’s not unusual for American investors to own European football clubs. Private equity firms have stakes in AC Milan, Atletico Madrid, Crystal Palace, and Genoa CFC, among others. However, what sets Clearlake apart is the magnitude of the gamble they’ve taken with Chelsea Football Club. Todd Boehly, a billionaire investor who made his fortune in loan trading, and his fellow co-owners have high hopes that Chelsea Football Club could one day become the world’s biggest football club with a sustainable financial model. However, whether the club’s current “buy-big transfer policy” will prove to be a successful application of Wall Street tactics or a risky move that will result in financial loss remains to be seen. Dan Jones, a sports business adviser, notes that while Chelsea’s spending has been bold, the outcome is yet to be determined both from a financial and footballing perspective.

The club has spent a huge amount of money on transfer fees for young players but aims to keep their wages lower than previous star players. This strategy was conceived by the club’s private equity dealmakers, who believe that the financial and cultural hub of London will increase the club’s value. Currently, Chelsea sits at 10th in the English Premier League, with the top four teams qualifying for the lucrative Europe’s Champions League. In 2021, Chelsea won the tournament and earned approximately €120 million ($128 million) in prize money. The club is still in this year’s competition but lost to Dortmund in the first leg of their knock-out tie. The club’s owners have publicly supported coach Graham Potter, although he is among the favorites for dismissal according to UK bookmakers.

Chelsea will face Southampton on Saturday, a team without a manager and currently sitting at the bottom of the table. Chelsea Football Club’s argument is that their current transfer policy is not simply throwing money at new players, but rather an example of financial engineering. However, there are rules in place to govern the finances of European football clubs, known as Financial Fair Play rules. These rules state that 90% of annual revenue can be spent on transfers and wages, decreasing to 70% by 2025. The aim is to prevent larger clubs from overspending to gain an unfair advantage over their rivals. To work around these rules, Chelsea has found a solution commonly used by financial firms to spread costs over a longer period of time. Rather than booking the cost of buying a player in the current year, the club is spreading the cost across a series of years. For instance, the signing of Ukrainian winger Mykhaylo Mudryk for £88 million from Shakhtar Donetsk will be divided over his eight-and-a-half-year contract with Chelsea.

Similar deals have been made for French defenders Wesley Fofana and Benoit Badiashile, and English midfielder Noni Madueke. According to Jones, the former head of Deloitte’s sports business group, offering players longer contracts can be a precarious decision. If a player performs below expectations, their lengthy contract could become a burden. Conversely, if they excel, their agent or the market may demand a renegotiation in the middle of the contract. From a profit and loss standpoint, it is simply a matter of timing. On the other hand, Jeremy Drew, head of sport at the global law firm RPC, suggests that extending transfer expenses over a longer period can help prevent breaches of financial regulations established by European governing body UEFA and the English Premier League. Additionally, Drew notes that the talent cultivated in Chelsea’s sophisticated academy is likely considered cost-free. As a result, any sales are recorded as pure profit. “Clubs are continually exploring various versions of financial regulations to locate the edges and angles,” Drew stated.

The new owners of Chelsea undoubtedly have the means to accomplish this. Along with billionaire Hansjoerg Wyss, Boehly, 49, is a minority investor in Chelsea. However, the actual financial power and risk rests with Clearlake Capital, which was founded by former Wall Street executives Jose Feliciano and Behdad Eghbali and holds around 61% of the football club. Clearlake Capital Group has a successful track record of identifying undervalued assets and profiting from them. In recent years, the private equity firm has invested in several tech companies, such as Dude Solutions, which it purchased for a modest sum in 2019 before facilitating its acquisition of smaller competitors. Clearlake then rebranded Dude Solutions and sold it to Siemens for $1.8 billion in 2022. Another successful investment was ProVation Medical, which Clearlake purchased for $180 million in 2018 and sold for $1.4 billion in 2021. Clearlake’s most recent investment is in the sports industry, specifically with Chelsea Football Club. The firm’s founder, Derek J. Boehly, has experience in sports acquisitions, having been part of the group that bought the Los Angeles Dodgers baseball team out of bankruptcy for $2.15 billion in 2012. This purchase was followed by a lucrative $8.35 billion deal with Time Warner Cable to broadcast their games on a new regional network. In 2020, the Dodgers won the World Series, and Boehly still holds a 20% stake in the team. Boehly’s experience in the sports industry demonstrates his willingness to pay a high price for potentially high returns. He also purchased a minority stake in the Los Angeles Lakers basketball team in 2021. With Clearlake’s successful history in identifying undervalued assets and Boehly’s expertise in the sports industry, the investment in Chelsea Football Club has the potential to be another profitable venture for the private equity firm. Boehly departed from Guggenheim in 2015 to establish his own investment firm, Eldridge. His focus was on finding companies that generate consistent cash flows that can be securitized. One of his portfolio companies is Security Benefit, a US retirement insurer with assets worth $45.9 billion, which often acquires portions of the debt. Upon joining Chelsea, Boehly initially served as interim sporting director, a position that typically involves negotiating with agents and executives. He wasted no time securing the acquisition of defender Marc Cucurella for £54 million after inviting him to his villa in Mykonos, Greece. Like other players, Cucurella’s contract is spread over six years. However, Chelsea now has a surplus of players, posing a risk of violating football’s financial regulations. Efforts to offload some players were unsuccessful, and one attempt fell through due to botched paperwork. This development raised questions about the speed of Chelsea’s acquisitions without corresponding sales. Boehly and Clearlake could have spread the same amount over several years, building a stable team and implementing their vision for Chelsea’s management. Boehly was open about his desire to own a Premier League club, saying to Bloomberg in 2019, “It’s difficult to buy quality without paying a premium. The question is whether you can continue to build on what you’ve acquired at that price. I don’t expect a 30% return, but I believe they are stable.” In the short term, fans, who are notoriously fickle, are losing patience. Cucurella was jeered by his supporters during a recent London derby game.

For the fans to begin believing in Boehly’s strategy, only a victory on Saturday will suffice.

Source : https://www.bloomberg.com/news/articles/2023-02-17/wall-street-brings-its-financial-engineering-to-english-football-at-chelsea