Description
Thesis: The agency business model continues to remain under pressure from structural issues (pressure from CPG, competition from agencies, dis-intermediated from digital) and cyclical issues (risks to global ad estimates as we enter end of cycle). OMC preferred way to play short given valuation, exposure to creative and over-earning from their headcount base
1. While structural issues are not new or unknown, like theaters they are likely to further manifest themselves
a. CPG companies continue to be pressured, putting pressure on agency fees
b. Competition with Accenture likely to intensify, especially if their acquisition of MDC Partners is successful
i. While OMC (like the rest of the industry) has benefitted from the issues facing Publicis in 2016-2017 and WPP 2018 going forward, both Publicis and WPP have laid out strategic initiatives to bolster competitiveness within the industry
c. Clients are increasingly in-sourcing projects traditionally granted to agencies, such as creative and programmatic; OMC has the largest exposure to creative, which has faced numerous issues (the first place where clients cut back spend, in addition to the fact that messaging to consumers has fundamentally changed over the past 10 years). According to Ad Age estimates, ~60% of OMC revenues are creative, versus <50% for peers
2. Risks to global economy create outsized risk to agencies; OMC P/E went from 18x at end of 2006 to trough of 9x in 2008. Given structural issues mentioned above, P/E trough likely to be lower this time around
3. Have continued to divest assets to boost organic growth
a. 2017 benefitted from divestiture of struggling businesses in 2017; however, 2018 organic likely to be in-line to below 2017
b. 2018, continued to divest assets that were a drag on growth (organic would be 40-50bps higher); however, creates an unsustainable way to manage organic growth
4. Employee productivity limits upside
a. Revenue per employee ~$200k, versus $140-$160k of peers; outperformance likely due to creative, which is typically a higher revenue and more productive business, but limits upside of further productivity compared to peers
5. Valuation
a. Currently trades at a premium to peers at 13x, versus IPG 12x, WPP 8.5x (not PF for Kantar), and PUB 10x
i. Assuming slight acceleration in organic (benefit 70-100bps from Ford, however offset from continued pressures in creative and end-of-cycle concerns) and slightly declining margins, get to EPS of $5.70 vs ST $5.80
ii. 10-12x 2019 EPS implies stock price of $57-$68, implying 10-25% downside
6. Catalysts
a. Q4 earnings, with clients continuing to pullback spend
b. Slowing global ad spend (GroupM has global ad spend from 4.5% to 3.9%; Magna 6.4% to 4%)
c. Accenture acquisition of MDC
d. Clients reviews in 2019 (OMC biggest net winner in 2018, with second most to defend behind IPG; represents ~30bps of revenues)
7. Risks
a. Accelerating top-line growth from client wins and divestitures (admittedly the bar to hit Street numbers for 2019 doesn’t seem too aggressive with organic flat at 2.6% versus 2018)
b. Agency M&A
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.
Catalyst
a. Q4 earnings, with clients continuing to pullback spend
b. Slowing global ad spend (GroupM has global ad spend from 4.5% to 3.9%; Magna 6.4% to 4%)
c. Accenture acquisition of MDC
d. Clients reviews in 2019 (OMC biggest net winner in 2018, with second most to defend behind IPG; represents ~30bps of revenues)