Are Arsenal facing a financial crisis?

If you thought financial issues were a thing of the past for Arsenal, well, this post might come as a bit of a surprise. The nice thing is, at least this time Arsenal’s concerns stem from the club spending too much money.

As the broadcast payouts by the Premier League to its member clubs exploded in recent years, measures were taken to prevent clubs from taking on more long-term financial commitments than were sustainable (see: Leeds United, Newcastle United, and Portsmouth, among others). Because clubs had become so reliant on broadcast money, the Premier League devised a soft salary cap which requires that a club’s biggest annual expense, player wages, only be substantially increased by non-broadcast money sums.

Why would this matter for Arsenal? Well, with big money signings Granit Xhaka and Shkodran Mustafi arriving this summer, as well as massive, looming extensions for Mesut Özil and Alexis Sánchez, Arsenal’s wage bill is continuing to rise as this soft salary cap comes into effect.

Let’s begin by taking a look at the rules and then see how they might impact Arsenal going forward.

THE RULES

Rule E.18 of the Premier League Handbook (download your free copy here!) states:

If in any of Contract Years 2016/17, 2017/18 and 2018/19, the sum of a Club’s Player Services Costs and Image Contract Payments exceeds £67m, £74m or £81m, respectively, the relevant Club must elect to either: (a) be assessed by the Board on the ‘Prior Year Basis’ (in which case, Rule E.19 applies); or (b) be assessed by the Board on the ‘2012/13 Base Year Basis’ (in which case, Rule E.20 applies).

Taking a look at Swiss Ramble’s biannual required read on Arsenal’s finances, the club’s wage bill for the 2015/16 year was £195.4 million. As Arsenal’s wage bill has only increased in recent history, and because 195 is greater than 67, 74, or 81, this section is going to apply to Arsenal each of the next three seasons.

Rule E.19 is most important to this analysis. Let’s look at it one section at a time:

Where the Club has elected to be assessed on the ‘Prior Year Basis’, the Club must satisfy the Board of any of the following:

Yay! You’ve elected the Prior Year Basis option. Please continue with Rule E.19.1:

that the sum of the Club’s Player Services Costs and Image Contract Payments has not increased by more than £7m when compared to the previous Contract Year; or

“Player Services Costs and Image Contract Payment” means anything a club pays to a player, including salary, insurance payments, and pension contributions. This section states that a club can increase those amounts by £7m from the previous year without any issue. We’ll call this £7m the “exclusion amount.” That “or” seems ominous though. Let’s read on to Rule E.19.2:

that the excess increase, over and above the £7m referred to at Rule E.19.1, arises as a result of contractual commitments entered into on or before 31 January 2013, and/or has been funded only by Club Own Revenue Uplift as compared to the previous Contract Year and/or Averaged Three Year Player Trading Profit; or

Translating from lawyerspeak into English, what this means is that if the wage bill increases by more than that £7 million exclusion amount from one season to the next, a club can cover that increase by using one, two, or all of the following methods.

The first is showing that those increases came from contract prior to 31 January 2013. This doesn’t mean contracts with players who have been here since that date, but rather contracts signed prior to that date. Possible scenarios where this might apply would be wage increases built into the contract for later years (the form for Premier League player contracts is built for different wages in each year of the contract) or performance bonuses that were triggered in the current year and not prior years.

The second method would be to show that the increase over and above the exclusion amount was covered by “Club Own Revenue Uplift.” Club Own Revenue Uplift is defined as “ any increase in a Club’s revenue in a Contract Year when compared with its revenue in either: (1) the prior Contract Year; or (2) Contract Year 2012/13, as elected by the Club in accordance with Rule E.18 (in each case, excluding Central Funds fee payments from its revenue in both relevant Contract Years).” Simply put, any increase in revenue from every source but Premier League broadcast payouts. This would include non-Premier League broadcast payouts (EFL Cup, FA Cup, Champions League), Commercial revenue, player loans revenue, and retail and licensing.

The third method is Averaged Three Year Player Trading profit. This is straight-forward. Fella, talk about (three year average) net spend! This being a separate requirement (as well as how Swiss Ramble breaks down income) would seem to indicate neither player sales nor “net spend” are used in the calculation under the second method.

Rule E.19.3 basically reiterates Rule E.19.2 and is not applicable to Arsenal’s situation as it deals with wage bill numbers far beneath what the club are paying.

Rule E.20 gives another way to meet the requirements of Rule E.18, but it is based on a club’s 2012/13 finances, something Arsenal would not be interested in at all. So, essentially, because of their wages, Arsenal are subject to Rule E.19.2.

IMPACT OF THE RULES ON ARSENAL

As mentioned above, these rules will obviously apply to Arsenal, due to their new signings and the necessity of contract extensions for key players. It could certainly factor into the ability to re-up Özil and Alexis, among others, this season. How, then, can the club account for their increases?

While in the past Arsenal might have been able to use the Averaged Three Year Player Trading Profit, their big spending in this area in recent years means that the club will not be able to utilize this method. Luckily, due to the “and/or” language for these methods, the spending will not count against the Gunners. The club will only be able to use Club Own Revenue Uplift to account for wage increases.

It will be essential from here on out, as long as this system exists, to make full use of the exclusion amount and any increase in income that season. From my rough calculations last month, Arsenal actually stayed roughly the same on salary from last season, so far. Mikel Arteta, Tomas Rosicky, and Mathieu Flamini actually had relatively high wages, the removal of which from our books acted as a ballast for Xhaka, Mustafi, and Lucas Perez’s deals.

It appears Arsenal may already be “gaming the system” with some of their activity. Many heads were scratched when news broke that Wojciech Szczesny and Joel Campbell, players who seemingly have no future with the club, were loaned out to sides who weren’t even covering the entirety of their wages instead of being sold. The seeming irrationality of these moves sparked complaint, but it appears a rational answer may be that these two were used to artificially inflate Arsenal’s wage bill this season. This may also be a reason that potential surplus-to-requirements Per Mertesacker might stick around all season instead of being allowed to move on in January.

Arsenal’s commercial deals have been a cause for concern, and should continue to be. The deals Arsenal sign are big, but they’re definitely behind the bigger players in the commercial game; for instance, when Arsenal signed a deal with Puma for £30 million a year two years ago, six months later, Manchester United signed one with adidas for £75 million a year. Chelsea’s newly signed deal with Nike is worth £60M/year, so Arsenal clearly have some ground to make up there. In the future, Arsenal must do better with its commercial dealings. Fortunately, this season would appear to be one where Arsenal can make use of increases in other sources of income.

Swiss Ramble also mentioned that property development income could be significantly higher, with the final two sales of property potentially occurring this fiscal year. Based off previous profits from property sales, it would not be surprising to see that figure increase by roughly £10m this year.

Arsenal also seem well positioned for a significant increase in Champions League revenue this season, compared to last season’s figure. Champions League payouts come from two sources, prize money and market pool payouts. Last season, we received €22, in prize money for making the group stage (€12m), winning 3 matches (€1.5m a win), and reaching the Round of 16 (€5.5m). Market pool payouts are based on a formula where the important variable is what league you are in and where you finished in that league. I haven’t seen a precise figure for last year’s payout but due to a large increase in the market pool and Arsenal finishing 3rd in 14/15, as opposed to 4th in 13/14, it probably was a shade less than €25m.

It’s safe to expect Arsenal will perform better in the Champions League group stage this season than last season, so prize money will almost assuredly be a few million euro higher (in addition to the money guaranteed for just showing up, wins and group stage placement also carry a prize money incentive). Also, due to the increase in market pool money and Arsenal finishing 2nd in last season’s campaign, that income will likely be in the €30m range.

If Arsenal can progress further in the Champions League than the Round of 16, that would be even more income over and above last year’s total (€6.5m for QF appearance, €7.5 for SF appearance, €11.5m for runners-up, and €15m for champions). Also fun, the euro has gained value over the pound, so there’s a significant increase in the value of payments in euros at the level of money we’re talking here.

It is also worthwhile to note that, while the sums are substantially less than the ones at play in the Champions League, the EFL Cup and FA Cup also have prize money and television distribution monies. Due to our average showings in those competitions last season, there is the potential for increase there as well.

How might Arsenal make use of this potential “extra space” if they do make deep runs in any of these competitions? Well, they could renew certain players and either front-load their salary to this season or make lump sum payments to existing players to, again, artificially inflate the wage bill for this season, when it seems probable we have the income increase to cover said increases.

I tried to look into whether lump sum payments are even allowable under the rules, and it would seem that they are, but only to existing players. Rule T.19 appears to be the pertinent regulation and reads as follows:

Unless otherwise agreed by the Board, no lump sum payment shall be paid or payable by a Club to a Player during the first year of his employment as a Contract Player [italics added for emphasis] with that Club save for:

Because that rule only restricts lump sums paid to new signings, it would appear giving current players a bonus would be permissible under the rules and would count as Club Player Services Costs.

Similarly, I could find no restriction in the regulations for front-loading salary to a certain time period, then lowering that salary in the future. An example of this would be if Özil wants a 5 year deal for £250k/week. That’d pay him an astonishing £65m over the course of his deal. He would receive the same total amount if he received £450k/week this season and £200k/week for the remainder of the deal. That figure would inflate this season’s total and create savings of £13m on the wage bill for next season, as well as counting for £2.6m/year less the remaining three years than a standard £250k/week deal.

Another way income could be increased is bumping up ticket prices going forward so, don’t be surprised if Arsenal doesn’t continue its price freeze in that area.

It would appear that If Arsenal can inflate their wage total this season, a season in which revenue should be significantly higher, it should give them the space to be creative for a couple seasons afterwards. All they would have to do is stay at this year’s inflated value, which should be easily possible. Because this salary cap is so soft, it appears most loopholes have been left wide open, with the exception of loose related party transactions (see: Manchester City). Ivan Gazidis and his team will need to take full advantage of these loopholes to keep Arsenal competitive with other big clubs.

It seems somewhat unjust that these rules implemented to rein in clubs that are tempted to overspend are negatively impacting arguably the financially-best run club in the league.

Further, while the rule was put in for good reason - to prevent a repeat of Portsmouth, Newcastle and Leeds spending tons of money they don’t have yet - in practice, it seems unfair that, in a financial climate where league broadcast money payouts continue to rise, the single largest source of income for most clubs, that clubs cannot use those funds in the calculus for increasing their wage bill.

This issue is certainly one to keep an eye on going forward, particularly with regards to looming extensions for current star players and continued recruitment of incoming star players.

(Author’s Note: I am not an expert on Premier League regulations - financial or legal - by any stretch of the imagination. If I’ve misinterpreted or missed anything, please educate me)