MDC Partners (MDCA) is an advertising agency holding company that owns major ad agencies like Crispin Porter + Bogusky, Doner,  kbs+ (kirshenbaum bond senecal), Anomaly, and 72andSunny.  Think of it as a smaller version of the major global ad agency holdcos (e.g., Omnicom, Publicis, WPP, Havas, Interpublic Group), but its the individual agencies are major global players, with both Anomaly and 72andSunny placing in the top-six of Ad Age's 2014 Agency A-List (with 72andSunny having won agency of the year in 2013).  MDCA's aggregate client list includes such companies as American Express, BMW, Samsung, Nike, Carl’s Jr., Target, Dominos, Kraft, UnderArmour, Vanguard, etc.

Agency holdcos are outstanding businesses.  Even when the world was about to end in 2009, MDCA saw its organic revenue decline just 5.5%; and agency employees are typically staffed to specific accounts, with the holdcos/agencies able to quickly downsize when contracts are lost.  Yet on my consensus-ish numbers, MDCA is trading at just 9.4x 2014 FCF / 7.7x 2015 FCF while sporting a 3.7% dividend yield, and I think there is realistic upside to the high-$20s on a one-year basis and $40+ on a three-year basis.

 

1) MDCA is the fastest-growing publicly traded holdco in the world, and I believe there are structural reasons this trend will continue.  If you look at the chart below, not only has MDCA grown roughly 3x faster than the four major agency holdcos, it has grown faster than any of them in every single quarter since at least 1Q11 (I didn't look back any further).  MDCA has focused its acquisition strategy on digital-oriented agencies, which, given MDCA's smaller size, have allowed these agencies to comprise a greater % of its overall mix.  MDCA agencies have been behind some of the more successful and notable digital/digital related campaigns, including Burger King’s "Subservient Chicken," the American Express "Small Business Saturday" campaign, Wisk's "Inside Dirt" online mockumentary series, and Samsung’s Facebook ad campaign for the Galaxy S3.

 

Quarterly Organic Growth (y/y)

Company

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13

3Q13

4Q13

1Q14

2Q14

Average

OMC

+5.2%

+7.2%

+7.2%

+5.2%

+5.1%

+5.1%

+3.5%

+2.7%

+2.9%

+2.8%

+4.1%

+4.2%

+4.3%

+5.8%

+4.7%

PUB FP

+6.5%

+7.6%

+6.4%

+2.6%

+4.1%

+1.6%

+2.0%

+3.9%

+1.3%

+5.0%

+3.5%

+0.7%

+3.3%

+0.5%

+3.5%

WPP LN

+6.7%

+5.6%

+4.7%

+4.5%

+4.0%

+3.2%

+1.9%

+2.5%

+1.9%

+2.8%

+4.3%

+4.1%

+3.8%

+4.3%

+3.9%

IPG

+9.3%

+4.7%

+8.7%

+2.8%

+2.8%

+0.8%

(0.9%)

+0.4%

+2.3%

+2.2%

+2.8%

+3.7%

+6.6%

+5.6%

+3.7%

MDCA

+26.5%

+21.2%

+17.9%

+6.7%

+5.4%

+8.3%

+6.7%

+11.9%

+10.1%

+5.7%

+9.3%

+4.9%

+8.3%

+7.0%

+10.7%

 

 

 

 

 

 

 

 

 

 

In addition to growing organically, the company targets 3-5% growth through acquisitions each year, but the deals are structured to preserve the company's 20% IRR hurdle rate.  Management's track record in this area is excellent, with the company claiming over 44% pre-tax returns on acqusitions over the past seven years.  Target companies are acquired at 5.5x-6x EBITDA, with MDCA only paying 2.5x up-front, with the remainder paid through performance-based earn-outs over a 3-5-year period.  The earn-outs decline in value if companies do not perform according to expectations, so the best way to think about it is acquired companies are using their own internally generated FCF to fund their payouts; and the longer-term nature of the payout structure also ensures executives/talent at the acquired firms maintain skin in the game long after their firms have been acquired.

 

2) The company is set to improve margins to the 16-17% range over the next three years.  Most agency holdcos have EBITDA margins in the 13-15% range.  MDCA's margins were 13.7% last year and should be close to 15% this year, but I believe they can go even higher.  Unlike larger/legacy agency holdcos that have myriad offices all over the globe, with resulting higher fixed cost structures (e.g., offices near old/new clients with employees spread over more offices, dead weight agencies, etc.), as a newer firm built in a more digital age, MDCA has been able to be more nimble about the offices it opens, resulting in a lower cost structure, and, I believe, higher structural margins.  Agencies, media, and PR firms are all 20%+ margin businesses, and as they grow, the company should generate further corporate opex leverage.  Further, while it's difficult to track a nebulous category like "digital," our research suggests a higher percentage of MDCA's business is focused on newer ad formats like streaming video, social media, unique PR campaigns, etc., which generate higher margins than traditional radio, TV, etc.  

 

International revenues represent ~6-7% of business, but have historically been loss-making.  The company eked out a small profit on its international business last year and profitability should continue to improve as the company gains greater scale internationally, which should help the overall margin profile.  Management believes overall margins can get to north of 17% over the next three years; I assume they get into the high-16s.

 

3) The CEO sold a ton of stock in March, causing the stock to completely break down, and it has yet to recover.  On May 12 and with the stock over $25, CEO Miles Nadal (who owned ~20% of the stock at the time) unloaded 35% of his stake ($81M) via an unexpected secondary that caused the stock to immediately collapse into the $19-22 range, where it has remained (despite a solid Q2 beat and EBITDA raise).  As I understand it, 90% of Nadal's net worth was tied up in the stock, and the sale occurred as part of an estate planning process that he claimed was long overdue.  Nadal has been a repeated buyer of the stock over the years and his conference calls are notoriously Rascoffian (Z reference) in their promotionalism, so the sale likely spooked a lot of current and potential investors; but after repeated conversations with management, I am comfortable that the sale had nothing to do with deteriorating fundamentals and was simply an example of the CEO failing to understand the signaling impact his sale would have on the stock.  While the company reported a solid Q2, I believe the company is likely in the penalty box for a couple quarters and/or until the chart looks cleaner.

 

MDCA has net leverage of ~3.55x FY14 EBITDA not including deferred acquisition considerations (DAC) that total just under $181M.  Even though these payouts are not guaranteed and are contingent upon the success of the acquired companies I think the proper/conservative way to model the company is to treat DAC as debt, which pushes net leverage to 4.50x.  The company has talked about delevering to ~2.5x (ex-DAC), but with interest expense in the mid-$50M range on ~$190M in EBITDA (with an annual cash tax bill of no more than $2-$3M for the next 5+ years), the leverage is not problematic from an operational standpoint.

 

MDCA's valuation is incredibly compelling.  The company has guided this year's FCF to $106-$110M (on a cap of just over $1B), and I believe there is upside to the high end of the range given the strong Q2 (record $53.7M in net new business wins) and management's track record of sandbagging guidance.  And while just 9.4x FCF on an assumed $110M in '14 FCF, if you believe the company can continue to grow organically in the 5-7% range while tacking on 3-5% growth through acquisitions, the math supports 20+% annual FCF growth.  Helping the company's FCF profile is its massive amortization-driven tax shield, which will keep it from being a meaningful taxpayer until sometime in the 2020s.  In general, you can expect ~90% flow-through from EBITDA to FCF.

 

	FY14E	FY15E	FY16E
Revenue	$1,270	$1,397	$1,537	FY14 guide plus mid-point of targeted 5-7% organic growth and 3-5% aquisition growth
EBITDA	$188	$215	$246
margin	14.8%	15.4%	16.0%	assume 60 bps of annual mgn improvement (mgmt thinks 17% 2017 is a realistic tgt)
- capex	$20	$22	$24
- cash taxes	$1.5	$2.0	$2.5	company won't be material cash taxpayer until sometime in the 2020s
- cash interest, net	$50	$50	$50
- non-controlling interests	$6.5	$7.0	$7.5
FCF	$110	$134	$162
P/FCF	9.4x	7.7x	6.4x
Net debt (reported)	$568	$566	$540	assume $50M paid annually for DAC
Net debt including DAC	$729	$676	$601	assume acquistions are paid up-front for 5.75x EBITDA @ 15% margins
EV/uFCF (reported)	10.7x	9.3x	8.0x
EV/uFCF (including DAC)	11.7x	9.9x	8.3x
Price @ 12x FCF	$26.41	$32.10	$38.70
cumulative dividend		$0.76	$1.52	assume unchanged from current $0.19 / quarter
Total return	+28%	+59%	+95%