February 23, 2021

Will Schalke 04 stay alive until the next summer?

The performance of Schalke 04 in the German football league has been incredibly unsatisfying during this season. Hence, it wouldn't be a big surprise to see Schalke dropping out of the first league after this season. Obviously, a relegation from the first league would have major effects on the long-term financials of the club. However, I came across the fact that Schalke has a bond outstanding that is already due in June 2021. And precisely this bond may present a great opportunity. In total, the Fussballclub Gelsenkirchen-Schalke 04 e.V. has bonds with a nominal value of EURm 50 outstanding, of which EURm 15.9 mature on July 7, 2021 and EURm 34.1 mature in 2023. Inexplicably, both the SCHALKE 04 ANL. 16/21 and the SCHALKE 04 ANL. 16/23 have very similar annual yields to maturity. That is something I simply cannot understand, as the risk profiles of those two bonds could not be more different from each other.

SCHALKE 16/21 - The Idea

As with every bond investment, the upside is capped while the downside can be quite significant. Hence, it is crucial to understand, what the key risk determents are. There are two major questions one has to figure out: Will Schalke make it until the end of July? And will they have available funding to pay back the EURm 15.9 due plus the last interest payment, i.e. a total of approx. 17 million euros?

To begin with, bear in mind that the first question is actually not related to whether Schalke may drop out of the Bundesliga or not. The financial impact from that will only roll in after the bond has been paid back. Also, the management of the club stated that the financial planning for the current season is secured and they do not expect any difficulties in obtaining the license for the next season (neither for the first nor for the second league). More importantly, the CFO stated that she is even "convinced that Schalke could [financially] manage a year" in the second league. While I would not underwrite that statement, we have to remember again that this is completely irrelevant to the maturity of our particular bond.

Yet, the second question is even more important for assessing the situation. To do so, we have to put the discussed bond into the context of the whole financing structure. Schalke has been highly levered for many years and reported total liabilities of EURm 205 per 30.06.2020. It is expected that the amount had further increased to EURm 240 per 31.12.2020 as the club obtained a state guarantee of EURm 40 during the second half of the year. The bond due therefore only represents a paltry 7% of the total debt.

Moreover, Schalke has recently shown that they can raise funding of this magnitude at relatively short notice. For extending some sponsoring contracts early, the club received a down payment of approximately EURm 6. In addition, the assets of the soccer club should be mentioned. With the debt-free Veltins Arena (a sell-and-lease-back might be possible), the valuable marketing and catering rights, and a possible sale of the eSports division (Sport1 estimates the value to around EURm 20), the club has still some final trump cards in its hand.

Summary: The bond appears to be securely covered

In summary, I think it is extremely unlikely that Schalke will not repay the bond due in July in full. The amount due of 17 million is simply too small. Rather, I am convinced that the sum was already budgeted for when the club applied for the state guarantee. For Schalke, but also for all other stakeholders, such as banks, sponsors, the city of Gelsenkirchen, and now also the state of North Rhine-Westphalia, there is simply too much at stake to let Schalke slide into insolvency because of a "lumpy" 17 million euros. Especially since the bankruptcy costs would probably be already higher than the amount due.
I am fairly certain that the bond maturing soon is simply being taken into the fold and only a few investors have compared the different risk profiles of the two outstanding bonds. In addition, the liquidity in the securities is extremely thin, which is why it is absolutely advisable to order with a limit.

Disclaimer: I am long SCHALKE 04 ANL. 16/21

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