Borussia Dortmund — Bumps in the road

Company description: A leading German football club

Borussia Dortmund has been a major force in German football for decades. Second only to Bayern Munich in terms of Bundesliga titles over the last 25 years, it was the first German club to win a European competition (the European Cup Winners’ Cup in 1966) and the Champions League in 1997. Last season was typically successful: victory in the German Cup, quarter-finalists in the Champions League and third place in the Bundesliga. The club’s fabled stadium (the Westfalenstadion, now formally SIGNAL IDUNA PARK) has long enjoyed the highest average attendance (over 80,000) in the country and indeed in Europe. Borussia Dortmund was formed as Ballspielverein Borussia 09 e.V. Dortmund in 1909 (hence the BVB 09 logo) and was listed on the Frankfurt Stock Exchange in 2000.

Despite a lack of comparability with peers, Borussia Dortmund is rated among the lowest. However, we prefer to focus on the company’s success in creating value in a sustainable business. Despite current uncertainties, an EV/EBITDA rating of 5x FY19e does not, in our view, reflect the long-term potential of powerful brand development, valuable media rights and sustainable positive cash flow, backed by freehold property, substantial subscription revenue, and hidden reserves from player investment. EV as a share of resilient and growing revenue is only 1x prospective. The company’s transfer policy continues to generate significant hidden reserves in player values. Despite a positive balance of transfers since 2014, the surplus of market value, estimated by www.transfermarkt.de, to net player assets is c €240m.

After its financial troubles under previous management Dortmund has successfully implemented a clear strategy focused on developing core revenue sources such as advertising, merchandising, match operations and broadcasting. Management is similarly intent on maximising success on the field without taking on new debt, while achieving a balance between financial and sporting interests.

The current year is headed for record EBITDA despite a disappointing season, notably in Europe and a consequent change of coach. The record outturn is driven by sales of star players, Dembélé and Aubameyang.

The company reports quarterly, with preliminary results for the full year due in late August.

Top drawer: Since its formation in 1909 Borussia Dortmund has become one of Germany’s most successful football clubs, having won eight national championships, four German Cups (current holders) and six German Supercups as well as the Champions League in 1997 and the European Cup Winners’ Cup in 1966.

During the 54 years of the Bundesliga the club has achieved top six status (the benchmark for UEFA competition qualification) on 24 occasions (also in the current season to date) in addition to its five titles. Indeed more recently, as shown in Exhibit 2, Dortmund’s performance in the Bundesliga has been second just to dominant Bayern Munich as the only other club to have won multiple titles in the last 20 years or so. The prolonged decline between 2003 and 2008 reflects financial troubles under previous management, while the 2015 dip proved short-lived (change of coach) and still allowed successful international participation as Europa League quarter-finalists.

Head coach: Peter Stöger joined Dortmund in December 2017, almost immediately after leaving Köln which he had managed since 2013. He took Köln to promotion to the Bundesliga in his first season with the club and back into European competition in 2017/18 for the first time for 25 years. Previously he enjoyed a long and successful association with Austria Wien, both as a player and then as coach and sporting director. He also won an Austrian league title with Rapid Wien which he represented in a European Cup Winners’ Cup final. He was a regular Austrian international (65 caps, including the 1998 World Cup). He is 51 and his contract at Dortmund runs until June.

Sporting director: Michael Zorc (55) has spent his whole career at Dortmund, first as player for 17 years (Bundesliga appearance record), culminating in the Bundesliga and Champions League success of the mid 1990s and then as sports director since 1998. His contract has just been extended to 2021.

The current squad of 28 has an average age of 25, which is similar to that of closest Bundesliga rivals, and includes a dozen current full internationals. Participation this season by matches started is shown in Exhibit 3, which also highlights key changes for 2017/18, notably Yarmalenko and Philipp replacing Dembélé in attack and Toprak and Dahoud coming in for Ginter and Bender. However, arguably even more significant is the change that did not happen in August, ie retention of Aubameyang despite intense speculation. His goal-scoring (21 in all competitions) remained exceptional until his exit in January, which prompted the arrival of Batshuayi on loan from Chelsea.

The performance this season has been remarkably mixed, seen in Exhibit 4. Top of Bundesliga after seven games (record start for coach Peter Bosz), then eight matches without a win, leading to Bosz’s departure in December, and a more impressive start (13 league games undefeated apart from a recent dismal 6-0 loss to Bayern) under Peter Stöger. With just five matches to go, Dortmund is now third in the Bundesliga, so well placed for the Champions League next season (top four qualify directly under the new format). However, a tougher schedule (Bundesliga points total of outstanding opponents) than immediate rivals Schalke and Leipzig (Exhibit 4) and only a narrow advantage ensure “a race to the end,” per coach Stöger. By contrast, this season’s results in European competition were uniformly poor, ie only two points from Champions League in stark contrast to a group win last season, followed by a bumpy run in Europa League, when the team rode its luck against Atalanta only to disappoint against Salzburg in the round of 16.

After its financial troubles (see page 9), Dortmund has successfully concentrated on developing core revenue sources such as broadcasting, advertising, match operations and merchandising. Management is similarly intent on maximising success on the field without taking on new debt, while achieving a balance between financial and sporting interests.

Dortmund’s positive reconciliation of conflicting interests is further highlighted by the disparity in its net transfer balance (amount received less paid) with those of certain fellow Champions League regulars. Exhibit 6 shows the last five seasons. The comparison with Bayern is telling as Bundesliga performance is also noted. While Dortmund has ensured European football at a fraction of Bayern’s net spend and easily outpaced other domestic rivals (over the last five years 14% more Bundesliga points than nearest, Bayer Leverkusen), there is a glaring 25% points inferiority to Bayern, with the recent 6-0 “thrashing” (www.bundesliga.com) by the new Bundesliga champions an unwelcome reminder.

Management aims to monetise this as follows:

The company’s senior management (see below) is backed by highly experienced management of the non-sports businesses and coaching staff.

Among major listed peers, there is limited comparability with BVB in terms of valuation indicators. By far the largest by market cap, Manchester United and Arsenal offer very limited free float, while Juventus has a majority shareholder and sizable net debt. The failures of Arsenal and Olympique Lyonnais to qualify for current Champions League suggest a lower outturn this year but both have booked much higher year-on-year transfer profit. Against available peer numbers (consensus forecasts are not available for most) BVB is rated the lowest, even using normal FY19e.

Value creation is emphasised by the company’s transfer policy, which is generating substantial hidden reserves in player values. The past two years saw average capital gains of c €63m (our estimate), even before the “exceptional” Dembélé transaction, and the scope for further gains is high. The surplus of market value to net player assets is c €240m if the reported December 2017 carrying value of €184m, which included Aubameyang, is set against sports website www.transfermarkt.de’s current valuation of €405m. Moreover, it necessarily does not allow for step-changes in the value of emerging talent, which Dortmund is so adept at identifying and which are attracting the attention of major clubs at ever younger ages. Potential prodigies such as Sancho, Isak and Gómez (Exhibit 5) may emulate the uplift (admittedly unrealised) of estimated €45m attributable to similarly youthful Pulisic, let alone the bumper return on Dembélé. Beyond this is the benefit of sustained transfer market buoyancy, highlighted by a doubling in spend by the five major European leagues over the last four years and by almost a third in 2017/18 alone (Exhibit 8)

This comes at a price in terms of player replacement but Dortmund is a net seller. More concerning is the threat of undue sporting detriment by disposals. With management’s objective to declare an annual net profit, the scale of intangible amortisation (over €60m pa) and operating cost pressures (marginal EBITDA in Q218 without the buttress of transfers) risks a disruptive volume of transactions. While we are satisfied, as above, that the company has the resources to meet such financial needs, it is reasonable to be wary about the sporting impact.

More immediately, our FY19 forecasts are subject to Champions League involvement next season (Europa seems almost assured as BVB now nine points clear of seventh place) as well as satisfactory appointment of a permanent coach and key striker. A strong end to the season could see both current interims (Stöger and Batshuayi) retained on a long-term basis.

The share price is at almost 50% discount to a simple sum-of-the-parts valuation of €9.50, based on estimated market value of players (€405m per www.transfermarkt.de), brand value (€420m at June 2017 per Brand Finance) and financial position (€48m net cash FY18e). Speculation about a change in ownership rules to allow investors to take majority stakes may have been calmed by the clubs’ recent vote to retain the so-called 50+1 rule, under which fee-paying club members must own more than 50% of voting rights. However, this may only be temporary as German clubs’ requirement to be competitive financially in Europe will not abate.

Borussia Dortmund’s turnaround has been remarkable. The company was at risk of bankruptcy in 2005, broadly attributed to extravagance, notably on foreign players, after Bundesliga success. New management (the current CEO and CFO) implemented a reorganisation programme, which included the restructuring of liabilities through a long-term fixed-interest loan from Morgan Stanley, cost-cutting and a strategy of revenue development and sustainable investment in players. Key initiatives included the repurchase of the stadium, eliminating high rental costs, and early repayment of the loan via a long-term agreement with marketing partner Sportfive, while early extension of flagship contracts endorsed the advertising strategy. Jürgen Klopp’s appointment as coach was in tune with management’s approach to player investment. A c €140m fundraising in 2014, backed by key sponsors and new partnerships, was a strong endorsement of strategy.

FY18e: H1 was a tale of two quarters (Exhibit 9). While Q118 was notable for the Dembélé transfer, which drove a doubling of EBITDA vs Q117, the following period was unaffected by transfers and saw a reduction in EBITDA (c €7m, relatively minor in full-year context) on flat revenue owing mainly to wage pressure, compounded by one-off severance costs related to the previous coach’s set-up. Other operating costs more than doubled largely owing to transfer-related expenses. In Q2 Champions League setbacks led to much lower (c 40%) international broadcasting income, albeit fortuitously redeemed by the initial benefit of the new deal on domestic TV marketing. While advertising remained encouraging (up 7%), marked by new Champion Partners Opel and bwin, there was a further decline in merchandising (down 24%), which is common across the league.

Despite such quarterly volatility, we retain our operational assumptions for this year. Our recent €37m EBITDA upgrade for H2 reflects January transfers (principally Aubameyang and Bartra) with no allowance for end of season dealings.

FY19e: we are now a little more cautious about transfer gains, given Aubameyang’s exit so soon after Dembélé. We assume FY19 transfers to be on a par with the average of the last three years, largely excluding the impact from exceptional Dembélé. However, management recently stated a need to adjust the squad, even if subject to the decisions of the new coach. Operationally, there should be a sizeable boost in broadcasting income (tba by UEFA – we assume up over a third on FY17) from the revamped Champions League; however, this is dependent on qualification over the remaining five Bundesliga games.