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mANuNited iPO
By Guilherme Baiardi

Taking you beyond the field

Most you have heard of Manchester United Football Club. Arguably the most famous soccer (football) team in the world, the Red Devils, as they are commonly known, have hundreds of millions of supporters (estimates range from 500 to 600 million supporters across the globe) and make millions of pounds every year through ticket sales, sponsorships and player transfers. Even though the Red Devils did not win the Premiership last season, losing at the last minute to their hated rivals, Manchester City, the team, in particular its management, had few reasons to remain sad. On August 11 of this year, Manchester United conducted what is by far the most significant IPO of any sports team in history, raising $233 million. Unlike American sports franchises, soccer clubs were never run as profit seeking enterprises, as teams would often make dubious financial decisions to sign the best players in an effort to win championships. MUFC started seeing a significant change in this regard when it was bought in 2005 by the Glazer family, who seemed to always have had an IPO in mind, levering up companys balance sheets to finance the acquisition, effectively leading to a leveraged buyout of the historical soccer club. This, coupled with very unique accounts in the financial statements, led to somewhat confusing and certainly new measures of income and expenses. What I will try to do here is guide you through some of the more interesting accounts. Revenues The club divides its sources of operating revenue into three distinct categories: Commercial, Broadcasting, and Matchday. Commercial refers to the sponsorships the club gets from companies such as GM, AON, Chevrolet, and Concha y Toro. These revenues amounted to 103 million in the latest FY (2011), or 32% of total revenues. Broadcasting is the revenue the firm obtains by selling its TV broadcasting rights to TV channels around the globe, primarily in Britain. These amounted for 35% of total revenues in FY 2011. Matchday Revenue refers to the money they make selling tickets and other amenities on match-day, and this stands at 111 million or 33% of total revenues.

Owners Joel (L)and Avram (R)Glazer


Far more interesting however, is the Profit on disposal of players registrations, which essentially refers to the profit made by selling soccer players. Unlike American sports, soccer players are not usually traded or picked up in free agency. Instead, they are bought and sold like commodities, with their values dependent on the players age and most importantly, current form. These values are extremely contextual and will vary significantly from year to year, making it an almost impossible task for financial analysts to try to forecast these numbers. For example, the profit on disposal of players registration for FY 2010 was 13.4 million, while in 2009 it was 80.2 million. This 83 % decrease is explained by the sale of Cristiano Ronaldo to Real Madrid in 2009. But the real question is, what are the chances of another Cristiano Ronaldo coming to play for MUFC? (Very slim.) Expenses This is by far the most interesting part, largely due to an expense named Amortization of players registrations. This is a recurring expense that refers to how much the teams players have lost value over the previous year. Again, this number is startling in its variability. The club, in its pre IPO financial statements, states that this number will be evaluated on a per player basis and that events, such as a career threatening injury or an exit from the first team, might result in higher amortization expenses for that particular year. Given how unpredictable soccer can be, this is another account financial analysts will have some serious trouble trying to forecast. These expenses are actually the second biggest operating expense for the club, second only to employee benefit expenses.

Story continued on page 4, please see Manchester United LIE-BOR Matt Parmett
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Kevin Goldfarb, Karan Parekh, Jeon Kang, & Charles Bagley


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NOVemBeR 2012

the futuRe Of sALes ANd tRAdiNG

By Teddy Xiong
As Wall Street prepares the earnings releases of its major investment banks this quarter, many analysts are projecting a continued decrease in sales and trading revenues. Once major revenue drivers for many bulge bracket banks, sales and trading departments have struggled in recent years to generate the same outsized returns as pre-recession years. From 2009 to 2011, overall trading revenues have dropped a sizable 38%, and revenues are expected to decline another 10% for 20121. Tightened regulatory rules, structural changes in trading, and sluggish macroeconomic environment have all combined to create major headwinds for trading desks. In response, major Wall Street firms have begun downsizing their sales and trading departments, even cutting entire trading groups, in an attempt to reduce cost structures. Despite this, the fast-paced, challenging job of a trader still attracts plenty of talented undergraduates every year, and prospective traders should understand some of the challenges that the industry may face in the future. Tightened Regulations Following the financial crisis and the recession, Congress passed the Dodd-Frank Act, the biggest change to financial regulation in the United States since the changes during the Great Depression. Intended to promote financial stability and increase transparency in the financial system, the Dodd-Frank Act introduced, among other things, tighter capital requirements, tougher funding limits, and higher liquidity minimums under Basel III for banks. It also eliminated loopholes that enabled banks to engage in risky and unregulated practices with over-the-counter derivatives and asset-backed lenders. Finally, the Volcker Rule, a provision in the Dodd-Frank Act that restricts speculative investments by banks, greatly limits proprietary trading within banks. All of these regulations squeezed margins for the various banks, and expectedly, the Volcker Rule had a tremendous impact on sales and trading divisions. Since the mid-80s, investment banks have engaged in proprietary trading to make outsized gains as servicing fees decreased. However, the new restrictions are predicted to take a sharp bite out of revenues depending on how strictly the Volcker Rule will be interpreted. According to Standard & Poors, proprietary trading in its most obvious forms contributed to just 1%-4% of total revenues, and only half of those activities would have to be immediately eliminated. However, under a stricter interpretation, the broad definition of proprietary definition proposed by the Volcker Rule would severely hamper a banks market making ability, limit inventories, and tighten hedging activities. This could impact trading revenues by as much as 50%, obviously a tremendous challenge for the industry. Additionally, OTC derivative regulations could decrease margins by as much as half, further straining the profitability of sales and trading groups. Structural Changes in Trading Operations Another challenge for sales and trading comes from structural changes to the inherent business model. Due to the increased regulations, investment banks have shifted to a lower-risk, lower-profit operating model. Meanwhile, trade orders continue to shift towards electronic channels. Nearly 70% of transactions on the Nasdaq come through electronically, generating lower margins than voice orders for most banks. High-frequency traders, seeking to take advantage of the slightest market mispricings through algorithms and low-latency trade times, take advantage of slower investors to make sizable profits. This both hurts the commissions of sell-side traders acting on behalf of clients and shrinks the spreads that they could potentially make when acting as liquidity makers. The impact of high-frequency trading is still not completely understood either. In the flash crash of 2010, the Dow fell 600 points and then recovered almost all of the loss within twelve minutes. Other mini-flash crashes have occurred regularly over a variety of assets, continuing to impact the ability of sell-side traders to execute their own trades. In addition, technological glitches have crept into trading operations: computer problems hurt the Nasdaqs IPO of Facebook this past May, and in August, the brokerage firm Knight Capital nearly collapsed after a technological error generated more than $400 million in losses. Low Volumes, Low Volatility, Low Risk Tolerance Finally, the macroeconomic environment has been exceedingly poor for profitable trade operations. Despite the strong rally in the US equities market, average daily volume in the third quarter was 6 billion shares, the lowest number since 2008 and nearly half the volume in the first quarter of 2009. As a general trend, volume has fallen year-on-year in twelve of the past thirteen quarters. This contrasts with previous economic recoveries, when volumes recovered within two years of the shocks in 1987 and 2001. Market analysts credit this to uncertainty from both traders and investors, fearing further negative news from the European debt crisis and still wary of the volatility of the recovery from the financial crisis. The increase in risk aversion has led to increases in cash positions and purchases of government bonds, hurting equities trading. Meanwhile, market volatility has generally decreased as banks have reduced illiquid assets from their balance sheets to stave off market price risk. The Volatility Index (VIX) has averaged 18.13 during the year, down from 22.09 in the same period in 2011 and 23.65 in 2010. For banks, this means fewer sales orders coming in from clients and less chances to generate revenues off of spreads, forcing them to reexamine the cost structures in their sales and trading groups. Many international investment banks have sold or eliminated parts of their trading divisions due to the sluggishness in equities trading and underperformance in derivatives trading. In spite of these structural changes, the financial services industry is still highly cyclical. Given a faster recovery in the global macroeconomic environment, trading revenues could easily begin trending back positively.

Trading revenue figures sourced from S&P Report on Global Trading Revenues, 2012

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NOVemBeR 2012


tRAde Of the mONth: Buy APPLe (AAPL)

By Kevin Goldfarb,Charles Bagley, Jeon Kang, Karan Parekh
Recent Earnings As you have most likely heard, Apples fourth quarter earnings missed estimates. Despite the missed analyst expectations, however, there remains little doubt as to the strength of Apple as a company. You know youre talking about Apple when the complaint is that profit grew only 24% year-over-year. The shining figure in Apples statements was their iPhone sales, which were greater than expected. Coupled with the fact that only 9 days of iPhone 5 sales were recorded in this period, Apple seems perfectly aligned for recordbreaking holiday sales. More disappointing, however, were iPad sales of 14 million units compared to estimates of 18 million. This might be explained by consumers waiting for the impending iPad Mini, which was released after the end of the fourth quarter. Apple is a company that is very well aligned for growth and a stock that is primed to pop after its 25% retreat from 52-week highs. Growth Opportunities Apple has three main growth opportunities: Growth Markets, Smartphone Consolidation, and Tablet Expansion and Ecosystem Growth. North America and Europe continue to be Apples largest market for profit; however, Apples key focus in terms of growth is in the Asia-Pacific market. With over 700% growth in sales and 3000% growth in profit in just the past five years, the Asia-Pacific region is eclipsing growth in North America by five-fold. Most important for continued growth in China, however, is the companys relationship with China Mobile. The largest cell phone carrier in the world, China Mobile controls 70% of the Chinese mobile market. Previously, the iPhone did not use Qualcomms TD-SCDMA technology, the proprietary 3G-network standard used by China Mobile. This was considered to be the most significant obstacle for Apple in China. The iPhone 5 does include this new technology, and a partnership between Apple and China Mobile is thus much more likely in the near future. One prospect for growth for Apple lies in the consolidation of the mobile phone market. As iOS (and Android) mobile software platforms cannibalize the previous leaders of the cell phone industry, the market share and revenue of these platforms will continue to grow. Apple and Android both showed strong growth in the second quarter of 2012 according to Gartner, with growth in mobile device sales to end users, and this can be largely attributed to the falling numbers of Symbian and Research in Motion, whose sales both declined by more than 50%. As these two previous leaders continue to decline, the void left in the market will be largely filled by Apple, with the new release of iPhone 5, and will translate to growth for the stock. The release of the long-rumored iPad Mini, the 7-inch version of the iPad, heralds Apples aggressive tablet market expansion. The all-new iPad Mini is compatible with existing iPad apps and its dimensions are reminiscent of the successful Amazon Kindle Fire. With that said, Apples plans to grow in the e-book market come to
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mind. On October 23rd, Apple released iBooks 3.0, which now comes with neat updated features like snippet quoting and vertical scrolling. Thus, Apples release of iBooks textbooks in January, the updated iBooks, and the all-new iPad Mini can work in tandem to attract new customers and increase Apples market share in online publishing. Apples foremost strength has always been the close tie between its hardware and software the versatile ecosystem seamlessly connecting all Apple devices and applications such as the AppStore, iTunes, and iCloud. Apples iBooks certainly is not one of the strongest performers for Apple, and thus the company has a lot of room to grow in this sector. With the iPad Mini optimized for easy handheld reading, Apples outlook on expansion is positive. In addition, Apples plan to launch online streaming radio in 2013 adds even more possibilities for the development of the Cupertino-based firm especially with iPad Mini, iPhone, and iPod. The Trade Buy shares of Apple on a one- to three-year investment horizon as we look for the company to continue to grow and innovate. This article was written on November 12, 2012 when AAPL traded at $542.80. All data is sourced from Bloomberg. Disclosure: We may or may not take a position in these securities.

By Matt Parmett

A Post-Mortem of the Libor Scandal

What is Libor, and why is it important? Libor, or the London Interbank Offered Rate, is an average interest rate that measures London banks cost of borrowing from other banks. Libor is one of the most important interest rates in finance because banks use it as a benchmark to determine short-term interest rates for interbank and commercial products. Overall, Libor serves as the reference rate for approximately $300 trillion worth of financial products, derivatives, and contracts and helps determine interest payments on about half of all United States variable-rate mortgages. For many banks and commercial customers, including students, homeowners, and small businesses, interest rates are determined by adding a risk premium to the Libor base variable rate. Libor is calculated based on overnight interest rates reported to the British Bankers Association by London banks. Banks disclose their unsecured borrowing costs for fifteen periods of time in ten different major currencies. Thomson Reuters then aggregates the data, excluding the highest and lowest 4 reports, and produces Libor interest rates for each maturity period to be used by banks around the world.

Story continued on page 5, please see LIE-BOR 3


NOVemBeR 2012

u.s. PResideNtiAL eLeCtiON

By Tony Murphy
The U.S. presidential election is not only an important political event but also an economic one: the winner is the guiding force of the federal governments spending and regulations for the next four years. However, are discernible trends in market performance after presidential elections and during each four-year term? At first glance, the data suggests that the stock market performs better under Democratic presidents than Republican. From 1928 to 2011, the Barclays US Equity Index had an average real price gain of 7% in the years of Democratic presidencies, compared to slightly less than zero percent return under Republican presidents. However, government bonds did better under Republicans, with an average nominal gain of 1.9% (Barclays US Bond Index) compared to an average loss of 1% with Democratic presidents. A possible reason for this difference in returns might be the divergent economic ideologies of the parties. Democratic presidents espouse Keynesian policies, with higher spending but also higher inflation. Republican presidents generally believe in balancing the budget through less spending. Equities would perform better with higher spending, as companies profit from government contracts, while government bonds would have higher returns with the lower inflation of a balanced budget. But such a simplistic explanation does not warrant a firm rule for investing. There are a lot of caveats to this data that make formulating a model difficult. First, theres not an extensive amount of data to make comparisons. There have only been 14 presidents since 1928, and the data for presidencies before this year is incomplete and reflects fundamentally different political parties. Second, the presidents decision-making power is limited by Congress. Since 1928, Democratic presidents have had control of Congress for 30 of the 44 years they have been in office; Republican presidents have only had control of Congress for 10 out of their 40 years. Less legislation is likely passed when two opposing parties control the White House and Congress.

Can We Predict Future Market Performance from the Winner?

Also, the president does not actually set economic policy. The Federal Reserve does this, and in a manner largely independent from the president beyond the appointment of its leaders. The monetary policy of the Federal Reserve has probably contributed more to market fluctuations than the legislation supported by the White House. Finally, what really drives performance in markets is not the presidential cycle; its the overall macroeconomy. The U.S. economy does not operate in a bubble, and a president may be in office during a global boom or bust that is largely outside of his control. Therefore, there is no clear trend for market performance that can be determined by the winner of the U.S. Presidential Election. The day after President Obama won reelection the DJIA dropped 2.4%, the largest single-day decline all year. Is this a sign that the market will fall under Obamas second term? For the reasons mentioned above, the answer is no. The major issue driving the current market decline is the fiscal cliff, the round of automatic tax hikes and spending cuts that will occur if a budget for the Federal Government is not approved. To create the budget, the President and Congress must work together to draft a plan that works for both political parties. However, with the House of Representatives controlled by Republicans, President Obamas power is limited. The presidents policies certainly impact the economy, but with so many other factors out of his control, there is no clear trend for market performance that can be determined by the winner of the election.

Manchester United, story continued from front page

Also of note is the clubs Capital Expenditures (CAPEX), which includes all investment in PPE as well as Net Player CAPEX. Somewhat similar to the previous player related accounts, this is the sum of all cash used for purchases of players and the cash generated from the sale of players. Since 1998, the club has only presented cash profits in the selling/buying of players in 2 years, 2005 and 2009. 2009, again, being an outlier due to the sale of Cristiano Ronaldo. The club tries to predict their expenditures by giving us an average of 14.3 million, but is quick to include a note saying, competition for talented players may force clubs to spend increasing amounts on players registration fees. Balance Sheet There is nothing particularly new here except for the accounts for players registrations and amortization that have already been

mentioned, but there are some interesting stories to be found on the liabilities side. Before being bought by the Glazers in 2005, the club was essentially debt free, but if we look at the most recent pre IPO filings, we can see that the clubs total indebtedness stands at 423.3 million. The club has released statements predicting that their total debt post-IPO will stand at around 354.4 million. The interest expenses have also been significant for the past three years, standing at around 50% of revenues back in 2010 and 2009. Finally, the clubs current ratio (current assets/current liabilities) stands at 0.63, meaning that the company will probably have to incur more debt to pay off their current liabilities. There is very little doubt that Manchester United is an extremely successful soccer club. It just seems that the business model that the Red Devils have historically used to win a record 19 English championships might not be entirely appropriate for investors looking for a company to put their hard-earned money in.
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NOVemBeR 2012 LIE-BOR, story continued from page 3

What did the LIBOR scandal entail? As mentioned above, LIBOR is calculated based on data reported to authorities by London banks. Because the banks themselves sell financial products based on the LIBOR rate, the data they report has a direct impact on their interest and trading revenues. Investigators estimate that traders and bankers began to systematically report falsified LIBOR rates in 2005 in order to inflate profits and appear healthier than rival banks. The United States Commodities and Futures Trading Commission (CFTC) alleges that the manipulative practices began in 2005 and occurred through 2009. In the case of Barclays, which was fined about $455 million for its role in the LIBOR fraud, traders and managers instructed the banks LIBOR submitters to report lower interbank borrowing rates. These lower rates drove LIBOR downward, increasing the traders profits on their derivatives positions in the U.S. Additionally, the lower reported rates made Barclays appear healthier than it was during the financial crisis by indicating that lending to Barclays was less risky than lending to rival banks. The widespread nature of the LIBOR manipulation scandal was unprecedented. Investigators uncovered vast networks of interbank cooperation in the fixing of LIBOR. About twenty banks have been incriminated in the international investigation thus far. At the height of the operation, one trader at the Royal Bank of Scotland (RBS) remarked that [LIBOR fixing] is a cartel now in London. The aftermath how did the banks get caught, and what can we learn from the scandal? Awareness of the banks manipulation of LIBOR grew gradually between 2008 and 2012. As early as May 2008, the Wall Street Journal published a study that revealed banks propensities to report understated interbank borrowing rates to the BBA. This report was contradicted by responses from the BBA, IMF, and Bank of International Settlements, which claimed that there was no concrete evidence of manipulation. After news of the scandal broke, however, the New York Fed and the Bank of England released documents which revealed that they were aware of LIBOR manipulation as early as 2007, but took no preventative or punitive action. Regulatory authorities began to investigate alleged LIBOR manipulation in 2011, and in February 2012 the U.S. Department of Justice began a criminal investigation into the matter. The LIBOR scandal was publicized after the announcement of the criminal investigation, which resulted in the record fines imposed on Barclays this year. As a result of the investigations, UK regulatory agencies will now be responsible for overseeing the calculation of LIBOR. LIBOR submissions from banks are now required to be based on actual transaction data rather than estimated rates. To avoid rate fixing as a proxy for managing public opinion of banks, the submitted rates will only be published three months after submission.
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Most notably, the LIBOR scandal renewed support for the separation of commercial and investment banks. Such a split would prevent a conflict of interest, as banks that submit rates to regulators would not be able to directly benefit from their manipulation. Sandy Weill, former Citigroup Chairman and CEO and staunch supporter of financial deregulation, spoke out in favor of reinstituting the Glass-Steagall Act, which formalized the split between commercial and investment banks. The LIBOR scheme, which occurred shortly after news of J.P. Morgans enormous trading loss went public, further eroded public confidence in the financial services industry and contributed to the notion that regulators and banks are embroiled in a mutually beneficial network of deception. LIBOR fixing in theory affects a large number of ordinary citizens, so politicians and fiscal authorities who support financial regulation may gain considerable populist support in this election year. Its a safe bet that the LIBOR scandal, when considered in combination with other financial frauds recently uncovered, will lead to greater public demand for regulation of the financial services industry.

Kevin Goldfarb Editor-in-Chief
Vice President of Financial Analysis

shruti shah
Design Editor

Jasmine Azizi & Alejandro Villero

Assistant Editors

Guilherme Baiardi, tony murphy, matt Parmett & teddy Xiong

Senior Financial Analysts

Charles Bagley, JeonKang &Karan Parekh

Financial Analysts

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