I just found out that Chelsea Football Club is applying ideas from financial leasing to their football player lending programme.
I was shocked. The analysis is quite interesting. To me at least.
The movie Moneyball, based on the book by the same name, showcased the use of financial ideas in sports, in this particular case baseball. There are two parts to it. The first was picking the right performance indicators and, just as importantly, ignoring well established but ultimately useless indicators. A similar challenge happened with the infamous Black-Scholes equation, which ignored the probability of the price of a financial security rising or falling when computing the price of a derivative on that security.
The second part of Moneyball is to look at the price per unit for the new performance indicators when looking at buying or selling a player. This showed that the market in baseball was inefficient and the first teams to adopt this new pricing mechanism reaped great rewards. In effect what was happening was a weak form of arbitrage. Again, this is similar to traders in the nascent derivatives markets who adopted the Black-Scholes pricing model.
What Chelsea is effectively doing is called an operating lease. In an operating lease you have a lender (called a lessor) and a borrower (called a lessee). The borrower will want the use of some asset for a specified amount of time but does not want to deal with buying and then selling the asset. The lender buys the asset and then lends the asset to the borrower for a specified time. The borrower pays a fixed recurring amount to the lender for the specified time. At the maturity of the lease the borrower returns the asset to the lender. The most recognisable form of operating lease is when you rent a car. It can apply to renting a house as long as it is for a fixed amount of time, also construction equipment, medical equipment, aircraft, ships, etc.
There are two main elements to understand in dealing with an operating lease. The first is the standard credit issues that comes up when a lender lends money to a borrower. The other, less well understood, issue is dealing with the underlying physical asset and in particular the residual value of that asset, meaning the price of the asset in the market at the time it is returned to the lender. Quite often a lender might not make much money on the payments from the borrower but if he manages the asset well he can make a great return on the residual value.
To understand this last point consider the car rental company Avis. It was consistently losing money until a newly appointed chief executive, Robert Townsend, had the insight that Avis was not a car rental company but a producer of second-hand cars. This made clear the importance of residual value and helped to turn the company around.
Chelsea is basically doing the same thing to great financial effect. It has players from its youth team who do not have much value in the market initially, the club keeps lending them out and then occasionally they hit the jackpot by selling one of the players for, in one case, a profit of about 10,000 per cent. What is interesting here is that unlike physical assets, which usually deteriorate in value immediately, a young football player gets better with experience and training.
If football player lending evolves the same way as leasing, you will see specialisation, starting with a sale and leaseback in which teams with strong balance sheets (or just private investors!) buy a player and then lend him out to poorer clubs. Clubs that are good at identifying talent, called suppliers in the financial world, can get paid for doing that separately from the actual lending. Clubs that train players better and/or reduce the probability of injury will be able to rent at lower rates than other clubs. The possibilities are endless.
This article was originally published in The National.