By Ray McKinney.
Murray International Holdings:
It happens a couple of times every year- a headline heralding another great performance followed by a few paragraphs that cite a series of impressive statistics. It is one of the UK’s best oiled PR machines in overdrive again. Scotland’s serious newspapers, The Scotsman (Edinburgh) and The Herald (Glasgow) seem to be locked in a mortal duel to curry most favour with one of Scotland’s richest men, Sir David Murray, founder of Murray International Holdings (MIH) and owner of Rangers Football Club. While the trials and tribulations of one of Glasgow’s football giants generates much public interest, it is MIH- Scotland’s oft acclaimed ‘largest’ privately held company- from which Murray’s position of esteem was created.
While the fawning sports writer coverage of the 1990s has given way to gentle probing of his stewardship of one of Glasgow’s sporting behemoths, the business pages of Scotland’s 4th estate seem oblivious to the biggest story in Scottish business in decades. For Murray International Holdings Ltd is heading for almost certain disaster. It is time for someone to yell “iceberg, straight ahead!”, and like the eponymous Titanic, it seems that momentum and circumstances are conspiring to leave few paths for salvation for the RMS Murray. It is a road to ruin which places the future of one of Britain’s best supported football clubs in grave danger.
This would seem like a staggering claim. Sir David Murray has carefully cultivated his brand: entrepreneur; mould-breaker; friend of Sean Connery and other celebrities; vineyard owner; benefactor to several worthy causes; a brilliant visionary who sees what is coming next ; and a man of action who successfully navigates dangerous waters where lesser men would tremble. All of this might be true, and it makes it especially difficult to believe that Sir David heads a conglomerate on the brink of collapse. Yet, by every meaningful business measure, that is exactly where his business empire sits today. While English football fans have seen a trickle of famous name clubs downsize into irrelevancy, for most Scots the idea of an enfeebled Rangers FC seems incredible, and its disappearance is just unthinkable. However, the changes that will be wrought throughout society by the credit crunch and recession are only just beginning to be felt. With the sun setting on his business empire, a clear and present danger over the future of his football division exists. As a subsidiary of Murray International Holdings, the fortunes and future of The Rangers Football Club are inextricably tied to those of its parent company.
The story of David Murray’s introduction to Scottish football is the stuff of Scottish folklore. A rugby player before a horrendous car crash resulted in both legs being amputated above the knees, Murray’s football ambitions had been limited to lowly Ayr United. After his attempts at buying this minnow were spurned, his friend Graham Souness, then manager of a Rangers team which was filled with English internationalists and sweeping all aside domestically, brokered an opportunity for Murray to buy the club from Lawrence Marlborough. At a price of £6m and the assumption of another £6m in debt, Murray effectively paid £12m for Scotland’s most successful team of the 1990s.
Marquee signings such as Paul Gascoigne, and continued dominance of Scottish domestic honours, helped burnish Murray’s image as a man with the Midas touch. He could do no wrong. He was a visionary who would lead Rangers out of the parochial battles of Scottish football and to “the next level” of European success. Scotland’s sports media tripped over themselves to write even more gushing homilies to this genius. It is now widely accepted that the wheels started coming off the Murray bandwagon as Rangers’ great rival in the east end of Glasgow came roaring back to life. In the late 1990s, facing a resurgent Celtic, freshly manned with visionary leadership of its own and now providing on-the-field competition, Murray upped the ante. In a combination of bombast and high-stakes poker that would be become very familiar in the coming years, Murray signaled to Fergus McCann, his counterpart at Celtic Park, that “for every fiver they spend, I will put down a tenner “. Murray would back up this claim, laying down £12m for Tore Andre Flo and a succession of continental stars. That these high priced superstars would flop in Europe was a financial disaster, but that they allowed Celtic to halt their league championship run at nine in a row was to breathe life into a domestic league long barren of real competition.
The rest of the football story is well documented. Both sides of the Glasgow divide have passed the mantle of success back and forward with Celtic proving to be the more dominant side in the last ten years. Murray’s enthusiasm for the game has appeared to ebb and flow. Periodically starving his club of investment and then using the credit lines of MIH to try to close the gap with Celtic. No custodian would think that bouts of starvation followed by feeding from a vat of caviar would form a sensible nutrition program for children entrusted to their care, but this is how Sir David has managed Rangers FC in the last decade. His mood swings regarding Rangers betray the ‘tells’ of a gambler who knows that he is running out money. He cannot afford to double down, but he does not want to crystallize his losses- forever admitting that the venture has been a failure.
Murray has been trying to make a graceful exit from Rangers for the last 3 years. Many times he has stated that it is time to hand over the reins to someone else. That no sale has taken place should be a matter of concern to Rangers supporters. Despite Sir David’s claim of being seconds from putting pen to paper on a sale (only to ask at the last minute what the new, unnamed buyers’ plans for the club were, and for the answer to have fallen short of what he thought best for Rangers FC), Rangers do not make an attractive purchase for anyone but the best heeled of ardent fans. If you include his initial purchase price, accumulated losses, and the opportunity cost of capital (i.e. how much he could have made just leaving his money in a unit trust) the honour of being the custodian of The Rangers Football Club will have cost Murray a sum approaching £200m. Such a fact can be skimmed over when discussing such issues with Scotland’s sports media, but men of sufficient means to even get to the table to discuss a purchase will also know how to calculate the cost of ownership. Owning a Scottish Premier League club is hardly the dream of you average Middle East oil baron or a Russian oligarch, so it would seem that Rangers’ savior must come from within the ranks of their existing fans.
The story of the credit crunch is now familiar. Banks lent outrageous sums of money to people who had no means of repayment. The banks’ managers got to pocket their inflated annual bonuses without much concern as to what would happen should these loans not be repaid. As the inevitable defaults on bad home mortgages mounted, financial institutions, from prestigious investment banks to the retail savings institutions on your High Street, began to fail at an alarming rate. Those banks which survived were propped up with government loans. Public funds are being used to plug holes in balance sheets created by private profits. (It is a bizarre world when events can offend the sensibilities of the right and left of the political spectrum at the same time). The first wave of the credit crunch hit home owners hard. This next shoe to fall will be commercial loans. Companies like MIH who borrowed too much and now face mountainous repayment schedules at a time when profits- if they exist at all- will be wafer thin. It is against this background of the credit crunch and a deepening recession that we examine the accounts of Murray International Holdings Ltd. It is a story of reckless lending and irresponsible gambling supported by illusionary profits created by the legal smoke and mirrors of flexible accounting rules.
MIH: the business
Sir David Murray made his money in the metals business. This is clearly a business which Murray understands, and his survival to date in this difficult field is worthy of respect. This is a pretty simple business: buying large quantities of raw material from steel mills and cutting to size for local customers. It is a stock-on-the-shelf and distributor company in a field that generates notoriously low profit margins. It is also deathly dull. Hence a man who feels that he has achieved something in life and wants his true genius to be widely known would feel the attraction of owning what was then Scotland’s best supported and most successful football club. With his brilliance acclaimed with great regularity in the newspapers, it must have been frustrating to have to live within the financial constraints imposed by such a low-profit business as steel. While you want from the sidelines, others- lesser beings no doubt- were fast accumulating great fortunes in other businesses: the temptation to expand into the UK commercial property market at its peak will likely prove to be the undoing of Murray International Holdings.
In principle, there is nothing wrong with a business using debt in moderation. Through the wonders of the corporate tax codes, interest on debt is tax deductable- and this increases the free cash flow available to the owners of the business. Debt is often referred to as ‘leverage’ because it has a multiplier effect on shareholder value during good times. However, it also multiplies losses- and significantly increases the risk that the company will go bankrupt.
Bankruptcy most commonly results when a company has defaulted on its debt obligations- payment of interest on time and/or repayment of the principle per the agreed schedule.
A business with very stable earnings, such as an electricity utility, can afford to take on quite high debt burdens as the chances of their earnings dropping unexpectedly is quite low. More cyclical companies, such as those in the commodities business for example, need to ensure that they can always pay their bills and their banks even in their worst possible year.
In absolute terms, the growth in debt at MIH is frightening. By January 2008, Murray increased MIH’s total borrowings by a staggering 14.7 times its January 2000 number (to £773.4m from a more respectable £52.7m). In the same time period revenues grew by only 3.6 times and operating profits by only by a factor of 1.2.
Business analysts will often look at the ‘capital structure’ (the ratio of debt versus shareholder money that is funding the business) to understand the level of risk that is associated with a business. When we look at MIH’s capital structure, we do not need advanced finance qualifications to see the danger. With a debt : capital ratio of 85%, the shareholders of MIH have only £15 at risk for every £85 that the banks have at stake.
This would seem like a great way of running a business. Get the banks to take more risk than you do, but you get to keep the all of the profit after you pay back the bank. However, interest payments loom like the grim reaper over every heavily indebted business. As can be seen in Figure 1 below, MIH has gone from a manageable 50% debt : capital ratio to its current 85% level within 8 years.
Lots of management consultants and finance professors made fortunes and reputations extolling the virtues of corporations loading up on debt. That was pre-credit crunch of course. However, even those who believed in the end of the ‘boom-bust’ business cycle would have still told you that extraordinary levels of debt could only be justified by extraordinary profits.
A closer inspection at the profitability of MIH will show that Murray’s decision to pile up debt did not even produce the minimum gains which would have been expected. Indeed, Murray would have been far better placing the borrowed money in a high yield savings account.
We can see that MIH is not especially ‘profitable’, but this analysis would be incomplete without discussing how other low margin businesses make their businesses make sense. Most retail businesses share MIH’s situation- selling commodity goods which buyers can purchase from any number of alternative suppliers. The best retailers- such as WalMart in the USA- understand that success in this business is not necessarily achieved in profit margin but in operational excellence. Just as debt is a ‘lever’ which multiplies profitability, asset-turnover (i.e. total assets / sales) works the same way. This involves many elements, but the ones of most interest in the case of MIH are ‘stock-turns’ and ‘Cash Conversion Cycle’. These are basically measures of how fast a business can turn the money it spends into cash received from customers. By any measure, MIH’s deterioration in performance turning costs into cash tells the story of the walk to the cliff edge for this company.
(click table above to view enlargement)
Inventory (or ‘stock’) levels have skyrocketed while the efficiency measure ‘Stock Turns’ has plummeted. This means that MIH is piling up money on its ‘shelves’. This money earns no return while it sits in inventory. Much of this inventory increase has come from Murray’s dive into the UK commercial property market which began in to show up in earnest in the 2005 accounts. £250m of the £307m inventory is attributed to development properties. Once started, MIH has to continue with construction. These developments continue to absorb cash for construction while the sale prices and rental values on which the investments would have been justified even just a year ago will look laughably naïve in today’s market.
While discussing the nuances of inventory, it is worth mentioning a curious effect of accounting rules. A company which is struggling to break even can reduce its expenses booked to a given year by creating inventory: cutting steel to length regardless of whether a customer has asked for it; building offices which no one needs… expenses which would have been booked to the profit & loss account in that year are capitalized and show up as an asset instead of an expense. (When the goods are eventually sold, the expenses are then recorded). Cash is still hemorrhaging, but the company gets to make press releases about another profitable year instead of having to explain red ink to an increasingly worried bank manager or to a bewildered media. Such ‘earnings management’ practices are common amongst struggling businesses. In most cases, there is nothing illegal about it, but bankers and financial analysts should be alert to such issues.
The effect of massively increasing inventory in MIH is best explained through cash flow. While many are baffled by the many seeming contradictions of accrual accounting, everyone understands cash. It comes in. It goes out. You can count how much you have today.
MIH’s statement of cash flows tells the story of the gamble that is being played out:
(click table above to view enlargement)
Cash from Operations reflects the real flow of cash resulting from the ordinary activities of the business- buying and selling metals, leasing office space, and of course from selling season tickets to football games in the south side of Glasgow.
Cash flow related to investments reflects spending which may take some time to yield a return: inventory; machinery; buildings; etc. The difference between Operations and Investment cash flows, if positive, is the free cash flow available to the owners of the business. If Free Cash Flow (plus cash on hand ) is negative, it represents a funding gap that can only be closed by selling more shares in the business or in borrowing more. Since 2000, MIH has had an accumulated Free Cash Flow of -£543.3m. This is a period which will be looked upon by economic historians as a gilded age. If you could not make money then, you will almost certainly not have survived the recession that followed. To lose such vast sums in an age of plenty, and to have gambled on UK property at the peak of the market, does not bode well for the future.
Debt Repayment Schedule:
MIH had to pay £55.8m in bank interest on its bank debt in the year up to 31 January 2008. Indeed, Sir David has had to borrow the money to meet MIH’s interest payments in six of the nine years between 2000-2008. (It is akin to putting your American Express bill on your VISA card). For a company bleeding cash, meeting such interest payments would be tough enough. However, the vultures who circle those who are ailing in the financial desert will be taking to the air upon realizing the debt repayment schedule which Sir David Murray faces.
In the coming year (to January 2010) MIH is scheduled to repay or refinance £406.9m to its creditors. In the current financial climate banks are not taking on high risk debt (or refinancing it) without a commensurate level of compensation in the form of interest and guarantees. If Sir David survives this recession, he may find that he owns a lot less of MIH than he did before it started.
When a business is successful, it will often generate profits beyond that which need to be reinvested in the business. These excess profits will begin to accumulate and it is in the shareholders’ best interests that this excess money be returned to them in some fashion- often as dividends. There is nothing wrong with a profitable business paying a dividend to its shareholders. It may seem surprising given the condition of MIH’s financial health that David Murray has continued to pay himself (and all shareholders) a dividend while having to borrow the money from the bank to do so. Since 2000, the Murray family have received £34.4m in dividends from MIH despite the fact that the company has had an aggregate negative free cash flow during that time. All of these dividends can be said to have come directly from bank financing. That HBOS has not imposed covenants to prevent their money going to a non-value added activity (i.e. dividends do nothing to help repay their loans) seems surprising. The bank’s faith in Sir David Murray, the man, must exceed their concern over the company’s stated finances.
Factors Affecting Survival:
Sir David Murray’s reputation as a successful businessman and much of his personal fortune is at stake. His fate is to a large extent out of his own hands now. There are several exogenous factors which will drive events:
Lloyds-TSB attitude to high risk debt: With over £730m of loans at state- secured against assets such as Ibrox Stadium and MIH’s property and steel inventory, the bank could be forced to acknowledge write-downs of £300-400m. If, as seems likely, that MIH is but one of many over-leveraged companies struggling to stay afloat in a sea of bank debt, the banks may prefer to delay avoid or at least delay foreclosures. Their own balance sheet worries may make keeping MIH, and others like them, on life support in the hope of a quick economic recovery and getting repaid in full. To start taking write downs on commercial bad debt may trigger another wave of bank failures.
Steel Prices: Global steel prices went on a roller-coaster ride during 2008. Starting the year at a reasonably stable historical price of about $630/tonne, leaping to $1100/tonne in July, and then collapsing back to $630 (and still falling) by year end, such dramatic price changes make life almost impossible for a steel stockist like MIH. Firstly MIH had been winding down steel raw materials inventory in previous year, so it will be unlikely that the company was able to exploit the price leap by selling off the shelf materials at the elevated prices of July. MIH will more likely have been paying the higher price for raw materials and getting squeezed by end users who would have been fighting price increases tooth and nail. How Murray played this commodities bubble will have been very important to the longevity of his business. While it is theoretically possible to have traded this market perfectly and to have made a small fortune in the process, many more will have- like home buyers in a rising market and fearing that if they don’t buy soon, they might never get in- bought as much inventory as possible for fear that it will cost much more later. Without any statement from Sir David as to how he played this market, we can only guess as to how this will have affected MIH. However, what is certain is that companies with inventory on their books purchased at or close to the peak will not be able to sell it at a profit today. The outlook for steel stockists is further darkened by the drop in thermal coal and iron ore prices in recent months, and the fact that the global steel industry is operating well below capacity. This means that the cost of steel may remain low for several more months. In the meantime, to raise cash stockists will have to sell inventory at a loss (based upon LIFO- Last In First Out accounting). This would represent the reversal of the benefit MIH will have seen while building inventory. Now, many stockists will be liquidating inventory at a loss to raise cash to survive. If the various government stimulus packages across the world do indeed generate enough steel demand to lift prices again by mid-2009, then there is some hope for Murray’s steel business.
UK Commercial Property:
However, prospects for UK commercial property are not good in anything like the timeframe Murray needs. Working only with MIH’s public record financial reports, we do not know what the margins that MIH was hoping to achieve on its property investments, but it also seems likely that MIH would have to recognize losses on these investments to generate any life giving cashflow. Actually recording a loss may remove the tissue behind which the bankers have been able to hide their embarrassment at allowing this situation to reach this state.
What Would Happen To Rangers?
In the event of an insolvency filing by MIH, the administrator appointed will have as his principal duty recovering as much value for the creditors (i.e. the bank)as possible. British insolvency cases tend to move quickly, and those subsidiaries for which a willing buyer cannot be quickly found will be liquidated. Collapsing commodity prices are not just affecting Sir David Murray, but billionaires found themselves to be mere millionaires in a matter of a couple of months in the autumn of 2008. This is no time for executive toys. Fortunes have to be remade and energies focused in areas with a reasonable chance of making a healthy profit. That Sir David has spent so prolifigately at Rangers, yet failed to achieve proportionate success or profitability does not make this an attractive business. That Murray has become a lightning rod for many of the frustrations of a fan base who feel that he has betrayed their club’s “traditions” will not help. Indeed, taking on the figurehead role of a club once famously described as a “permanent embarrassment and an occasional disgrace” will be unlikely to whet the appetite of many of Scotland’s wealthiest people. In the event of an MIH bankruptcy, if a credible buyer does not come forward quickly- with an offer that would pick up a sizeable part of the £26m in bank debt and other debt obligations assigned to Rangers FC, then the closure of one of Scotland’s most famous institutions cannot be eliminated as a possibility.
It is unlikely to come to that. Given how little money would be raised in a liquidation (Rangers’ stadium being worth almost nothing to anyone except Rangers), the bank might accept a very low figure for the club. Glasgow City Council might help a prospective consortium of buyers by purchasing the stadium and leasing back the ground to the club- thereby releasing funds to operate the club at least in the medium term.
Whatever happens, it is a cautionary tale for football fans everywhere. When the media, sports and business alike, fail to fulfill their watchdog role, then problems are left to turn into a cancer. There are many questions that must be asked about how Sir David Murray’s hubris and gambling instincts have been allowed to place so many vested interests, not merely in football, in major jeopardy.
Click any of the following table to view in full size (opens in separate window)