F1 ‘Expected’ To Drive Up Its Loans To Pay Teams

Formula One is on track to boost its borrowings and draw on its $402 million cash reserves in order to pay its ten teams and cover its overheads if its 2020 season gets the red light due to the coronavirus pandemic according to credit rating agency Moody’s.

F1’s ten teams have been stuck in limbo for the past three weeks since the auto racing series put the brakes on its first eight races after a member of the McLaren squad tested positive for COVID-19 before its season-opener was due to take place in Australia.

F1 initially said that the season would re-start in May but later pushed it even further back. In a statement two weeks ago F1 said that it still plans to hold “between 15-18 races” this year but didn’t say when the season-opener would take place. Instead it said that it will get underway “at some point this summer.”

That doesn’t just require the 15 to 18 destination countries to be free of coronavirus but also the UK, Italy and Switzerland as the teams are based there. After the debacle in Australia, where F1 was seen as having brought a case of coronavirus into the country, future race hosts probably won’t take any chances.

It only took one person to test positive to give the red light to the Australian Grand Prix so it is likely that the teams’ home countries will have to be completely clear when F1 decides to race again. However, given that the UK, Italy and Switzerland currently have more than 150,000 active coronavirus cases it could take far longer than summer for them to be ready.

The uncertainty over when the season will actually rev up has fueled concern for the teams. The longer it takes, the greater the chance they could hit the wall due to their high-octane running costs.

Seven of the teams are based in the UK and file publicly-available financial statements along with one of the outfits based outside the country. The Swiss-based Sauber squad is exempt, as is Italy’s famous Ferrari outfit as its F1 team is a department of the auto maker itself. The latest filings for the eight others show that the average annual running cost of an F1 team is $219.5 million (£189.4m) and each one employs a staggering 573 staff.

The Williams, McLaren and Racing Point teams have put staff on the UK government’s furlough scheme but, across all of the squads based in the country, it will only cover up to 35% of their salaries. The tiny figure says more about the turbocharged pay checks in F1 than the stimulus measure which sees the UK government covering 80% of workers’ salaries. It is capped at up to $2,900 (£2,500) a month until June with employers footing the bill for the remainder.

This will keep the majority of UK workers ticking over as the average salary in the country was $35,177 (£30,353) last year according to the Office of National Statistics. However, it accelerates to an average of $100,000 (£87,000) across the seven F1 teams which are based there. Staff at even the lowest-paying team get more than double the amount that the government will contribute.

The average is inflated by payments to the superstar drivers at some, but not all, of the teams. This is because certain drivers set up offshore companies which receive their fees instead of them being on the payroll. Regardless of how they get paid, the drivers at all three teams on the furlough scheme have taken pay cuts which will further narrow the gap between costs and revenue.

The teams’ revenue comes from three sources – sponsorship, payments from team owners and prize money which is paid by F1 and represents around 68% of its underlying profit, known as Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). That is on track to reverse sharply this year due to the lack of races and the same goes for payments to the teams by sponsors as they are fueled by television coverage. Even the team owners may struggle to pour more money into their squads.

All of the teams use engines provided by four auto makers – Mercedes, Ferrari, Renault and Honda. The first three also own their own F1 squads and all of them have been battered by the coronavirus as people are reluctant to travel. Moody’s recently reported that global auto unit sales are set to crash by 14% in 2020 with a 21% drop forecast for Western Europe alone.

The four titans of transport in F1 have lost a combined $29.9 billion of market value since the start of this year. Mercedes’ owner Daimler has plummeted by $13.1 billion, whilst Honda has lost $9 billion, Renault is worth $3 billion less and even Ferrari is down by $4.8 billion. It makes it less likely that they will be able to bankroll an F1 engine programme which costs around $1.4 billion. The window to turn away is fast approaching as the contracts which commit the teams to race in F1 all expire at the end of this year.

It explains why McLaren boss Zak Brown recently said to the BBC that he “could see four teams disappearing if this isn’t handled the right way. And then, given how long it takes to ramp up an F1 team, and given the economic and health crisis we are in right now, to think there would be people lined up to take over those teams like there has historically been…I don’t think the timing could be worse from that standpoint. So I think F1 is in a very fragile state at the moment.”

You don’t have to look too far back to find evidence of what could happen as the banking crisis in 2008 drove Honda, Toyota and BMW out of F1. There is good reason for this. In a booming market, F1 gives brands a halo which makes them stand out against their rivals. However, when times are tight, it stands out as an easy way to cut costs.

F1 has said it will delay by a year the introduction of the costly new aerodynamics regulations which were due to be launched in 2021. It will save the teams development money this year but even when the regulations remain stable, the smallest teams still have to spend around $20 million on development so this measure doesn’t seem to be sufficient. Crucially, it is merely a tweak to the existing plans for F1 when what appears to be needed are completely new ones.

F1 announced last year that it will introduce a cap on team budgets in 2021 and it still plans to do this. However, this will only limit costs to $175 million annually which still seems far too high given the inevitable austerity that is heading our way thanks to the coronavirus.

Brown told the BBC that all teams have now agreed to lower the cap to $150 million but he described this as “rounding around the edges.” Instead, Brown has proposed a limit of $100 million and told the BBC that he would be prepared to compromise on $125 million. “If we don’t make an aggressive enough budget cap and some people feel they have to top up this year and have no chance of getting it back,” he said, “then they ask themselves: Why are they in it?”

F1’s regulator, the Fédération Internationale de l’Automobile (FIA), has a blueprint on file which could solve this problem and then some. It was drafted in 2003 when the FIA proposed sweeping changes which would see all the high-technology driver aids consigned to the trash can. The changes even introduced standard rear wings for the cars and scrapped radio communication between the pits and driver whilst computer telemetry, allowing the engine to be adjusted by the team during a race, was also set to be banned.

“Severe constraints will be placed upon electronic control of throttles, clutches, differentials and actuators [electronic mechanisms to engage a gear],” said then-FIA president Max Mosley. His plans were often years ahead of their time and even included introducing a sustainability plan for F1 back in 1997 as we have reported.

The regulation changes in 2003 would bring costs down to around $50 million annually so they were prescient even by Mosley’s standards. Although only elements of them made it to the finish line, they make a useful guide as to what F1 may need to do now to get a grip on costs. However, the teams also need revenue to keep their wheels turning.

Prize money represents the teams’ biggest source of revenue and came to $1 billion last year. Although this represents around 68% of F1’s profit, it isn’t entirely tied to its fortunes. The bulk of the prize fund is derived from 47% of F1’s profits which is then split into two equal amounts. One half goes to the top ten teams based on their positions in the standings whilst the other is divided into equal amounts and goes to the teams which have finished in the top ten in two out of the past three years. That’s not all.

In 2013 we revealed in a report for sports broadcaster ESPN that a further 7.5% of F1’s profit is handed to the top three teams based on the number of races won in the four seasons prior to 2012, when this benefit was first introduced. This bonus pot is known as the Constructors’ Championship Bonus (CCB) fund and according to F1’s company filings, it comes to “the greater of 7.5% of our Prize Fund EBITDA, and US$100 million.” So if 7.5% of F1’s profit is less than $100 million, as it may be this year, the CCB fund would come to that amount.

It is guaranteed regardless of the results that the teams achieved the previous year and, according to F1’s company filings, it sees “the team ranked first receiving 37% of the CCB fund (with a minimum payment of US$37 million), the second team receiving 33% of the CCB fund (minimum US$33 million) and the third team receiving 30% of the CCB fund (minimum US$30 million).”

The money is split between Ferrari, McLaren and Red Bull Racing which leads the CCB pack due to its string of four championships from 2010. This gives it a minimum of $37 million from the CCB fund with McLaren getting at least $33 million for being ranked second and $30 million going to Ferrari. However, that is far from the end of the story.

This is because Ferrari also gets its own dedicated prize money pay-out as well as sharing in the 47.5% and the CCB Fund. The dedicated prize pot gives Ferrari “the greater of an amount which is capped at 5% of our Prize Fund EBITDA and US$62.2 million.” This is also paid regardless of Ferrari’s results the previous year and it comes in return for the Italian squad being F1’s longest-standing team having been racing in the championship since it was launched in 1950.

Like the CCB fund, if 5% of F1’s profit is less than $62.2 million, as it may be this year, the Ferrari payment would come to that amount. In a research note last week, Moody’s said that if the 2020 F1 season is completely canceled, the business should continue to tick over as it could pay the teams and other overheads with its cash reserves and a $500 million line of credit.

Moody’s said that F1 has “substantial liquidity headroom of around $900 million, comprising $400 million cash balance and $500 million undrawn committed revolving credit facility. Moody’s expects this to be sufficient to absorb cash outflows from…team payments, other overheads and interest costs in the event that the 2020 season is canceled.”

It gives some comfort to investors in F1 which is listed on the Nasdaq with the ticker FWONK. If the teams weren’t paid there would be a risk they could crash into bankruptcy which wouldn’t just jeopardise this season but 2021 as well. Belt-tightening is essential as well and staff are likely to be collateral damage in order to bring the teams’ costs down. However, the existing staff numbers seem to be unsustainable in the current climate anyway so these job cuts appear to be inevitable.

“This is a great opportunity for radical cost cutting, budget caps etc, which have been needed in F1 for a long time,” says a well-placed source. “I can’t remember who said ‘never let a crisis go to waste’ but the current situation is a classic example. It would allow things to be done that one could never do in normal circumstances…The UK government is not going to bail out F1, some of the teams have very limited resources and the rich teams are dependent on car manufacturers who are about to have their own problems (witness their share prices). Without radical action, it could be the end of F1 as we know it.”

Moody’s says that the same conclusion could be reached if F1’s debt and cash aren’t sufficient. “The assessment of liquidity headroom in a full cancelation scenario is complex and there remains a degree of risk that liquidity would not be sufficient, although Moody’s considers this risk to be low.”

Even this might not be the end of the road as Moody’s adds that “the company may also be able to draw on support from its owner, Liberty Media Corporation which currently has substantial available resources.” Time will tell if it needs to use them.