The Discounted Cash Flow (DCF) method is one of the most widely used techniques in financial engineering for valuing a company. It consists of evaluating and discounting the future cash flows of the company studied. It is based on the construction of a Business Plan from 4 to 10 years with a forecast of revenues and expenses based on precise assumptions as well as a discount rate generally determined via the CAPM model.
The value of the company (EnterpriseValue) is then the sum of Free Cash Flows to Firm discounted value to which a terminal value is added calculated using the Gordon Shapiro method or by applying a multiple to a key indicator which may be the operating result. The value of the shares (Equity Value) is then the calculated enterprise value from which the net debt must be subtracted.
Certain limits may hamper the application of this financial method within professional sport. For example, few clubs manage to regularly generate positive cash flows, making it difficult or even impossible to apply DCFs. In addition, the exercise is perilous to build a Business Plan over a long period as the income is correlated to the sporting results but also to parameters exogenous to the life of the club – including in particular the renegotiations of television contracts. By carrying out a BP over a short period, most of the enterprise value will then depend on the terminal value. Finally, the calculation of the discount rate based on the CAPM method works very well for industries with many companies listed on the stock exchange – which is not the case for professional sports. In the excellent book Creating Value in Football, the authors did this exercise and calculated a discount rate of 6.5% for the sector. Although it seems low, we will rely on this rate for our work below.
Application – fictitious example
To illustrate the assessment of a professional club, we started with a totally fictitious example but whose financial data is based on a ranking in the soft underbelly of Ligue 1 over the next four seasons. The first version of the valuation does not include the capital gains made on the disposal of players, normally considered as exceptional income.
Business Plan over 4 years of a Ligue 1 club – v1 – Fictional example
In this first version, we reach an enterprise value of €37.5m. Considering a net debt of around €10m, the value of the shares is then €27.5m.
The 2e version includes normalized income from capital gains on player sales. In the example in question, it is considered that the club manages to earn €5m per season in capital gains.
Business Plan over 4 years of a Ligue 1 club – v2 – Fictional example
Taking into account capital gains on player sales changes the situation considerably. The enterprise value then amounts to €96 million and the value of the shares to €86 million.
Should capital gains on the sale of players be taken into account in the valuation?
This question is the subject of debate among sports finance specialists. And the opinion will necessarily differ depending on the defense of the interests of the seller – who will push for the recognition of capital gains in the assessment – and those of the buyer.
Nevertheless, it does not seem abnormal for a training club which derives substantial revenue from the transfer market each season to take this line of revenue into account in the evaluation via the DCF (even if it is exceptional recipes). And this is all the more true if the sums recovered are not reinjected into the policy of acquiring new players.
Is the DCF method used in the world of professional sport?
Traditionally, sports finance players prefer to use the method of multiples to obtain a first estimate of the target club. With the specificity that this multiple is applied to turnover – whereas in other industries it is more commonly applied to operating profit or even net profit. A multiple that is calculated from past trades in the market while making adjustments based on asset structure. This sectoral approach makes it possible to quickly validate initial hypotheses. Nevertheless, the DCF method is not completely ignored in the sports world.
“The multiple method is generally the preferred method when negotiations are already underway with potential buyers. This allows you to have a market vision. Nevertheless, it is interesting to cross-reference this first evaluation with the DCF method. We thus start from a multiple approach and then we cross the first valuation with the production of a Business Plan to evaluate future cash flows. This makes it possible to estimate the consistency between the amounts planned by the buyer in his investments and the generation of value. And to determine if the return will be sufficient ”concludes an expert in deals within French professional football. At the rate of transactions in professional sport, we have not finished hearing about DCFs.
To go further 👇
⚽️ How is the value of a professional football club calculated?
💰 Several finance professionals, having worked on club sale files, give us their analyzes 👇
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