Despite a Whole Lot of New Cash, Why I Am Not (Yet) Investing in Borussia Dortmund GmbH & Co.KGaA

Borussia Dortmund GmbH & Co. KGaA (FRA:BVB), is getting a whole bunch of cash in the very near future.

Jersey sponsor Evonik Industries AG (FRA:EVK), outfitter PUMA SE (FRA:PUM), and stadium namesake SIGNAL IDUNA Allgemeine Versicherung AG, together subscribed for up to 17.7 million of the 24.5 million newly issued BVB shares. In other words: The football club’s funds will swell by between 82 million Euros and 114 million Euros. And this in addition to the 26 million Euros that were nabbed from Evonik just two months ago.

That’s an impressive sum. However, I still don’t believe that the stock is a good choice for “buy and hold” investors.

A valuation of just below 400 million Euros
The three aforementioned companies would secure 21% of the future shares outstanding with their 82 million Euro investment. This corresponds to a valuation of almost 400 million Euros for BVB. However, if you now think that will vault Borussia Dortmund into the financial sphere of German flagship club Bayern Munich, here is a comparison: The club from southern Germany received 110 million Euros from Allianz SE (FRA:ALV) for a an 8.33% stake, valuing the entire club at 1.32 billion Euros. That’s right, this is more than four times the valuation of Borussia Dortmund.

But what’s more relevant to us is the difference that the up-to-140 million Euros would make to BVB’s financial strength. Let’s have a look into the annual reports from the last four years to find out.

*Free cash flow is defined as operating cash flow minus investment into intangibles (mainly players) and tangible assets (e.g. stadium renovations)

Source: BVB GESCHÄFTSBERICHTE.

Revenue has grown continuously, to more than 250 million Euros, thanks to the club’s success in Germany’s Bundesliga and the European cups. The present capital position seems small by comparison. But let’s look at the free cash flow — the money that is available to Borussia Dortmund each year after investments in players and other assets. Free cash flow amounted to an average of around 16.2 million euros in the last four years.

And now we see the capital increase put in the right perspective: In order to earn 140 million euros in cash, the club would have to repeat the success of the past four years in the eight years to come. I would venture to say that the club’s management would immediately accept it if someone guaranteed that. Now, the club has the opportunity to get this sum in an immediate payment. So why wait, this makes sense for the club!

How is the capital going to be deployed?
The short-sighted investment of the cash received from the IPO in 2000 almost drove the club into bankruptcy. Current management under the leadership of Hans Joachim Watzke has different plans. They want to:

use the proceeds [of the capital increase] to nurture growth… and, as a second step, increase the player budget.

40 million euros will be used to repay debt and the remaining funds to will be held as a liquidity reserve to increase financial resilience.

What does that mean? Firstly, Borussia Dortmund is going to follow its policy of promoting sporting success through sustainable work instead of trying to force it at increased financial risk. Secondly, the lowered debt load should lead to lower interest payments on the order of approximately 2.2 million euros per year (calculated with an interest rate of 5.4%, which is the weighted interest rate for all long-term liabilities of the club in the last annual report).

This effect could be reversed by future dividends though — paying this year’s dividend of 10 cents per share for 24.5 million additional shares would mean a higher dividend on the order of 2.45 million euros. And these are to be paid after tax. However, as opposed to interest payments, the club can pay dividends at its own discretion and make them dependent on future financial success.

Superb performance financially and on the pitch… so where are the risks for investors?
In short: in the fast pace of the sport. Two German championships, twice a runner-up, a DFB Cup victory, two DFL Supercup wins, and a UEFA Champions League final appearance, that’s what Borussia Dortmund has achieved in the last four years. However, they have regularly lost their top performers — in 2011 it was Lukas Barrios, in 2012 Shinji Kagawa, Mario Götze in 2013, and this year it was Robert Lewandowski. And there seems to be no end of the trend, judging by the current discussions about Marco Reus.

If you look at the transfer-adjusted revenue of BVB compared to the top clubs in Europe, it’s easy to understand why it’s harder for this club than for others to retain its stars.

Die transfer adjusted revenues of the 15 strongest-selling clubs in Europe

Source: DELOITTE. “DELOITTE FOOTBALL MONEY LEAGUE 2014“.

So far, BVB has been able to compensate for these losses thanks to its skills in scouting, signing, and integrating new players. And investors can be confident that the club will continue to rise after setbacks in the coming years due to the the long-term contracts with the team who built the foundation for the club’s success — namely, coach Jürgen Klopp (under contract until 2018), sports director Michael Zorc (2019) and CEO Hans-Joachim Watzke (2019).

Nevertheless, sustainable success on the pitch — and the ensuing economic success — can only be achieved when top performers can be retained in the team more easily in the future. The capital increase is a step to significantly improve the financial environment to reach this goal.

Conclusion
The additional capital expands the financial resources of the BVB significantly. But the club is still far away from playing in the same league financially as Europe’s top clubs. The long-term success of the shares will be strongly linked to the success of the team on the pitch. And the fact that Borussia Dortmund is still far behind its main competitors with respect to its financial capabilities, an increased risk exists for “buy and hold” investors like me.

However, today’s development presents quite an interesting time to enter a position in BVB shares for investors with a medium term investment horizon. The two most important things to watch out for are:

• Will the club be able to retain its top performing players better than before?
• What will happen in the years 2018/2019? Can the club continue to rely on the services of Jürgen Klopp, Michael Zorc and Hans-Joachim Watzke, or what are the succession plans?

If you have an optimistic view on these questions, then the BVB shares a definitely worth a second look, even for long-term investors. However, I am still not convinced that this will be the case.