Who would have thought that Hearts would beat Rangers to offering shares in the club to its fans? At this stage let’s ignore the club/company issue. What I want to focus on is the section issued by Hearts detailing “Risk Factors”. It can be found here.
No one can accuse Hearts of “soft soaping” the fans. The Risk Factors are spelt out most starkly. It will be interesting to see the contract with the Rangers Prospectus when it is issued.
Clearly the two organisations are very different, in terms of debt, fan base, finances and reliance on third parties.
Many of the Risks associated with Hearts will not apply to Rangers and vice-versa. However it does give a template for things to be looked at.
The statement makes clear that acquisition of shares “involves a significant degree of risk”. It states that “specifically in the context of an equity investment in a Scottish football club in the current economic climate and last reported net debt of £24 million you should not expect any income from or return on your investment”.
“You should not acquire shares in the company unless you are capable of evaluating the risks and merits of such investment and have sufficient resources to bear the loss of all the money invested by you.”
It then states:-
“The Directors are committed to strategies that are intended to deliver long term value but there is no guarantee that those strategies will succeed.”
It is quite clear therefore that there ought to be no expectation whatsoever of any financial return from investment in Hearts shares, nor even a speculative one. Therefore it would seem to be the case that this one is not targeted at institutional investors, unlike that of Rangers. This one is for the Hearts die-hards only, it seems.
Specific Risks Factors – Negative Balance Sheet
The company’s Balance Sheet is negative and the company would be insolvent without the ongoing support of Mr Romanov’s bank, as owner, or alternative funding.
That statement alone is enough to establish that normal loan funding from the banks, other than UBIG, is not available. Even in easier economic times, telling a lender that you are insolvent was unlikely to achieve an offer of loan!
Hearts state that there is no guarantee UBIG will continue to support Hearts in the future. The Board is comforted by UBIG having supported the club since 2006 by funding and debt re-structuring.
However, past performance is no guarantee of future performance, as we well know.
Specific Risks Factors – Trading Activities
The share value depends largely on how Hearts perform on the field of play. In addition changed in the economy are stated as matters which can substantially and adversely affect the company’s prospects.
Specific Risks Factors – No Market for Sale of Shares
The document makes clear that there is no market or dealing arrangement, so anyone who does buy shares will have problems selling them or even to obtain information about their value.
As it states:-
“Investors may realise less than their original investment and have a significant risk of losing all of their investment.”
There is no guarantee of an “exit route” as it may be difficult or indeed impossible to sell the shares acquired.
Specific Risks Factors – No Dividends
In light of the financial circumstances of the company, the Directors have no intention of declaring a dividend for the foreseeable future. Therefore, as there is no income from the shares, and no easy way of selling them to achieve value, they can only be a sentimental purchase.
Specific Risks Factors – Debt to UBIG
As at June 2011 the debt owed to UBIG stood at £22,413,000. Interest accrues on that at 4.5%. That means an annual interest bill of just over £1 million, or £20,000 per week, each and every week of the year.
Although UBIG has confirmed that it will not seek repayment of the dent in season 2012-2013, the position is to be reviewed on 1st July 2013.
As it makes clear, if UBIG demanded full payment, then the company would be insolvent and would face liquidation. As the assets are all secured by a Standard Security and a floating charge, both in favour of UBIG, there would be no value in administration. If UBIG calls up the debt, Hearts cease to exist (subject of course to the Trigger’s Broom analysis applied to Rangers).
Bearing in mind the apparent volatility of Mr Romanov, as expressed in his various public announcements, Hearts can never really be sure of their position. To be fair, any club which was indebted to a bank, and which was insolvent but for the bank’s support, would be concerned for its future.
The chill winds of the economic decline have affected every financial institution. Banks want their money back!
Specific Risks Factors – HMRC
This is the most note-worthy of the factors mentioned, I think, and especially so in light of the travails of Rangers.
There is a “significant ongoing dispute with HMRC. The tax man has claimed unpaid tax liabilities of around £1.75 million, excluding interest and penalties from Hearts. This relates to “arrangements between Hearts and Kaunas FC in relation to certain players who were loaned to Hearts by Kaunas.
The directors are robustly defending the claims, we are advised.
There is a clear recognition however that “the burden of proof is on the Company and the tax will be payable unless the Company is successful in challenging the claims, which will be heard by the relevant tax tribunal in November 2012”.
I do not recall as simple and clear a statement being made by Rangers, whether under the stewardship of Sir David Murray, Craig Whyte or Duff and Phelps. However it is quite clear, and is the same as happened with Rangers – assessments were made. The taxpayer refused to accept them and appealed. At the appeal it is for the taxpayer to establish the tax is not due, and not for HMRC to establish that it is.
I will write later about the specifics of this issue as regards SPL and SFA regulations, but for now would observe that it is unlikely that this matter will take as long as the Rangers Tax Case to be decided!
However, even with a hearing ending in November, a decision might not come till the summer, depending on the complexity of the case and the length of the evidence and submissions. Equally though, there could be a decision in December or January.
When interest and penalties are added, it is possible that the liability could exceed £3 million, depending on the precise circumstances.
Specific Risks Factors – Possible Need for Further Debt Capitalisation
UBIG have made clear that they are willing, over time, to consider allowing the club’s supporters to attain majority ownership of Hearts. This share offer is seen as a first step on the road, but there is no commitment made by UBIG that the process would continue nor any commitment to transferring ownership.
However it is made clear that further share offers may be required to capitalise the debt owed to UBIG, thus diluting the ownership of non-UBIG shareholders. As long as UBIG holds 75% or more of the shares, it is in position to force through resolutions effecting such further debt capitalisation.
So, even buying shares in this offer with a view, ultimately, to achieving a majority stake is not in any way guaranteed.
Specific Risks Factors – UBIG Control
The statement makes clear that UBIG, being owners and not directors, owe no legal duty to the company and are entitled to act entirely in its own self-interest.
The directors take comfort from the support extended since 2006, but as is made clear this is not unconditional and is not a long-term commitment.
Specific Risks Factors – Working Capital Shortfall
The plan for the share issue is to raise sufficient funds to ensure that the working capital requirements of Hearts are met till the end of season 2012-2013.
However, if the HMRC case goes against Hearts, or the offer is under-subscribed, then there will be insufficient funds to meet the working capital requirements and, as the statement says, they will need to seek additional funding.
It is likely that any such funding would be very expensive, being the equivalent of a payday loan.
Otherwise Hearts fans can look forward to even more of the star players being sold in the January transfer window, and the problem with having raised the share issue and the stark choices now is that it makes it a buyer’s market. Purchasing clubs will know that Hearts need to sell. This will affect what they can get, as will the requirement to be paid as much up-front as possible.
One wonders if the remaining instalment of Lee Wallace’s transfer fee has been paid by Rangers, and if not, whether the astute Mr Green might offer payment now, with a substantial discount for early settlement. After all, Rangers have over £10 million in the bank, based on his comments about season ticket money not having been spent yet. If the sum still due is £800,000, then offering, say, £400,000 now would likely meet with Hearts’ approval.
The Risk section of the statement ends with a section in bold making clear that investors should be prepared to sustain a total loss of their investment.
There is no possibility that anyone could later say that they were misled as to the prospects of the shares.
What is being offered are shares in a company where the buyer’s holding can be diluted without their approval; where there is no market for the shares; where there is no prospect of a dividend; where the company is effectively insolvent and therefore the shares are worthless the minute the buyer writes a cheque for them.
I suppose this might raise more money than passing round buckets at matches to collect cash, but how much more?
Hearts are seeking less than £2 million to cover the working capital shortfall. Bearing in mind that Rangers, in SFL3, boast of having cut the wage bill to £6 million, this shows clearly how, even in restricted circumstances, the Ibrox team is still a financial giant, at least in Scottish football terms.
Some Rangers fans would delight in thinking that it was their demotion which has caused this black hole in Hearts’ accounts – I suspect that is s systemic problem, caused by various factors, including the down-turn.
Of course the share issue comes just before the Tax Appeal. If it goes against Hearts, then all the funds raised, and the same amount again, could be needed to meet the bill.
HMRC has already, and repeatedly, had to take action against Hearts for delayed payment. This suggests that there is likely to be little leeway given to them. Are we therefore looking at a share issue which might have to be paid in its entirety to HMRC, with a further share issue seeking twice as much to pay the balance and fill the working capital shortfall?
It is a clear indication of the challenges facing Scottish football financially. Is it worse than before – not when there have been a string of SPL teams entering administration over recent years.
Will Hearts make it to the end of the season? Probably.
Will Hearts ever pay off the debt to UBIG? With interest running at £1 million per year, that seems very unlikely.
The Hearts experiment by Mr Romanov proves yet again that, to end up with a small fortune by owning a football team, you need to start with a large fortune! Still Fergus McCann is the only person in Scottish football history in recent years, and possibly ever, who has disproved that adage.
Posted by Paul McConville
NB None of the above should be taken as a recommendation to buy or not to buy these shares. Anyone intending to purchase shares in Hearts should seek independent financial advice from a suitable investment adviser.