Auto racing series Formula One has reported that revenue fell last year for the first time since 2005 driven by the cancellation of a controversial race in the Middle Eastern state of Bahrain.
Revenue reversed by 4.3% to $1.3 billion but, interestingly, the fees paid by the organisers of the Bahrain Grand Prix did not go down as a result of the cancelled race, they increased.
The race was cancelled in early 2011 as a result of violent clashes between Bahrain’s Shia majority and the ruling Sunnis. When the decision was taken F1’s chief executive Bernie Ecclestone said that the series was “not insured for this sort of thing” and would not receive a fee from the race organisers unless they could find a slot for the race later in the year.
“If and when it is rescheduled they will pay their usual fee,” said Mr Ecclestone adding that it is “close” to $40 million. In the end the race did not take place at all in 2011 and instead returned the following year. Mr Ecclestone’s comments led many in F1 to assume that no compensation was paid for the missed race but in fact this was not the case.
Recently-filed financial statements for F1’s parent company Delta 2 state that revenue for the year ending 31 December 2013 was down due to “the prior year benefiting from the deferred recognition of significant revenues in connection with the cancelled 2011 Bahrain Grand Prix.” This fuelled a spike in 2012 when it boosted revenue by 12%.
Further pressure was put on F1’s top line by a Grand Prix in Spain being dropped in 2013. It left a total of 19 races and although India and South Korea have been cancelled this year, they have been replaced with new events in Austria and Russia so the outlook is bright.
The financial statements add that revenue was also dented by “significant amendments in 2013 to the terms of two material rights contracts. These other factors were partly offset by the benefit of revised TV rights arrangements in Italy, growth in logistics’ revenue and underlying contractual uplifts in other TV and race promotion agreements.”
The latter point refers to one of the tricks under the hood of F1 which has enabled the revenues of the race series to steadily climb even during the recent recession.
F1’s revenue comes from four main sources: broadcasting contracts, race hosting contracts, sponsorship and corporate hospitality. Delta 2 receives revenue from the first two and is the highest-level F1 parent company which files publicly available financial statements.
Money from the sale of F1’s sponsorship and corporate hospitality goes to businesses based in the tax haven of Jersey which do not need to file publicly available accounts. It is understood that they generated a combined $400 million last year taking the combined revenue of F1’s ultimate parent company Delta Topco to $1.7 billion.
Whilst Delta Topco’s 2012 and 2013 financial statements are not available, there is data from 2003 to 2011. It shows that, over the period, revenue increased at a compound annual growth rate of 9.6% with the only dip occurring between 2004 and 2005 when there was a tiny drop of $1.1 million to $1 billion.
The trick under F1’s hood is that the majority of its broadcasting, race hosting and sponsorship contracts contain clauses which escalate the fees payable by up to 10% every year. It insulates F1 from economic downturns but doesn’t guarantee that profits will always rise.
Last year Delta 2’s costs accelerated by $77.1 million to $1 billion and the biggest single component of this increase was a 6%, $45.7 million, rise in prize money payments to F1’s 11 teams. They were paid a record $797.5 million making it Delta 2’s single biggest cost.
The prize money is calculated as a percentage of the company’s underlying profits, known as Earnings Before Interest Tax Depreciation and Amortisation (EBITDA), and 2013 was the first year of a new contract which boosted the teams’ share from 59.6% to 63%. The new deal replaced the previous contract which was known as the Concorde Agreement and expired at the end of 2012.
Further pressure was put on Delta 2’s bottom line last year by the beginning of a new agreement with auto racing’s governing body the Fédération Internationale de l’Automobile (FIA) which led to a four-fold increase in the fees it receives from F1.
The combination of the decline in revenue and increase in costs had a noticeable impact on Delta 2’s profits as Britain’s Daily Telegraph newspaper recently revealed. The net result is that after the teams were paid and external finance costs were deducted, underlying profits fell by 32%, $136.7 million, to $285.9 million.
F1’s chief financial officer Duncan Llowarch says he is happy with the performance “taking into account the continuing effects of the global economic downturn on the countries staging the championship’s events and in other territories with which the group does business.”
Mr Llowarch took advantage of record low yields in the global leveraged loan markets last year and led a refinancing of F1’s bank debt. It reduced the interest rate by 140 basis points to between 3.25% and 3.75% above the London Interbank Offered Rate (LIBOR) – the rate at which banks in the London market can borrow funds from each other.
F1 repaid $21.8 million of the loan principal during the year leaving a total of $2.1 billion outstanding. Annual interest repayments on the bank debt reduced from $171.4 million to $118.6 million last year thanks to Mr Llowarch’s manoeuvre. However, this didn’t increase Delta 2’s profits. Instead it made a net loss of $296.1 million which narrowed from $472 million in 2012.
At first glance it may seem hard to understand how F1 could have made a net loss of $296.1 million when it had underlying profits of $285.9 million. In fact there is a good reason for this. In addition to its bank debt, Delta 2 also has inter-company loans on its books and pays non-cash interest on them. This came to $459.4m last year which is why the company ended up making a net loss.
The bulk of the loans are repayable by Delta 2’s subsidiaries which are based in the United Kingdom. They receive the lion’s share of its revenue but their tax bill is minimised thanks to the loans which were paid to them by their offshore counterparts in the F1 group. Huge interest payments on the loans push the UK companies into loss which means they don’t have to pay tax. Since the interest payments are received by offshore companies the money can be paid out as a dividend without tax being deducted there either.
Like all aspects of the finances of F1, it is a frightfully complex system, especially for sports reporters who do not specialise in covering it. This is highlighted by recent flawed analysis from F1 blogger Joe Saward who claimed “it is true that the teams are taking about six percent more than they were getting in 2012, as a result of the new Concorde Agreement deals, but this cannot be blamed for the drop of 32 percent in the profits. The reality is that the company seems to have loaned most of its profits to other companies in the group as a way of reducing its tax burden.” This is inaccurate on several fronts.
Firstly, it is plainly false to allege that the increase in the team payments “cannot be blamed for the drop of 32 percent in the profits.” This is because the $45.7 million rise in prize money payments was the biggest single component of Delta 2’s $77.1 million increase in costs.
It is also of course wrong to say that “the company seems to have loaned most of its profits to other companies in the group.” In fact, the reverse has taken place. Rather than loaning money, Delta 2 has taken out loans from other companies in the group and it pays interest to them which in turn leads to it making a loss rather than a profit. That’s not all.
In the comments below the blog post a reader asks “when you speak of F1 Group “generating” $1.7 Bn per year, I take that to be gross income, correct?” In response, the reader is told that it is “EBITDA.” Again it is far from the truth as EBITDA is underlying profit, which is calculated after costs have been deducted, whereas the $1.7 billion is gross revenue. It isn’t the first time this kind of flawed claim has been made.
Earlier this year Lotus F1 released a document confirming that its majority owner, the private equity firm Genii, had sold a 10% stake in the team and Joe Saward claimed that it had been bought by the law firm handling the transaction. There was no evidence for this and unsurprisingly, the article about it was soon removed after the firm released a statement saying “we are legal counsel for Genii Capital & @Lotus_F1Team and have not purchased nor plan to purchase shares in Lotus F1.”
It followed the claim that the sale of another stake in the team “has been completed” which was equally false. These kind of slip ups are one thing but another recent report took it to a new level by explaining in detail the current importance of a company in the F1 group called Delta Prefco which has in fact been closed since 2012.
It is crucial to root out and address these errors as they arise to prevent them from becoming accepted, embedded and false conclusions being drawn from them. The business of F1 is already complicated enough as it is.
Likewise, on first glance it may seem that F1’s performance has been reversing due to its revenues decreasing but in fact this was partly driven by a big boost the previous year. In F1 things rarely are as they seem.
