Description
Short Omnicom (OMC), the largest worldwide ad agency. I believe that consensus top line, margin and bottom line estimates are too aggressive. Additionally, the company has two converts that will likely be put back to OMC during 2009 resulting in higher interest costs and a higher tax rate.
Cap Structure / trading stats:
$8.8B mkt cap ($28.25 stock x 311M shares)
+ $3.2B debt ($2B convert, $1B senior notes, $115M drawn on a revolver)
- $555M cash
= $11.4B EV
Avg volume 3.3M shares ($93M)
Thesis:
- Street top line estimates are unrealistic
o Consensus revenue estimates are for (2.7%)
o f/x alone will cost the company 500bps off the top line (47% of top line is outside the US)
o global add agencies based in Europe (WPP LN, PUB FP and HAV FP) saying the global ad market will be down 3-4% next year….there is NO difference between the revenue split / geography split b/t the global co’s and OMC
o assuming -5% from f/x and -4% (base case) market and adding back a small amount for acquisitions puts me at -8.5% top line vs the street at -2.7%....said differently, even if the street is accounting for the change in f/x, consensus revenue estimates would imply the global ad market is growing next year - impossible
o recent revenue trends showing a sharp deceleration supporting my thesis
Rev Growth (total)
Tot US UK Euro RoW f/x added
Q3 07 11.8 7.4 14.8 17 19.5 3.6
Q4 07 12.7 9.5 6.7 15.6 24.3 5.0
Q1 08 12.5 7.6 5.2 21.9 23.9 5.1
Q2 08 11.2 5.5 -0.4 19.6 28.8 5.2
Q3 08 6.9 3.8 -4.3 13 18.3 2.1
- Street margin estimates are also too high
o According to the company they can hold margins relatively stable (-60-80bps) with a -3% top line market (margin at which the consensus eps of $3.08 is being driven). At down 5%+ margins have a realistic chance of going back to the 11% seen during the ’91 recession
- Co has $1.5B in coco converts that will likely be put back to the company in 2009. The company will have to borrow against their revolver to repay these converts. The company has been making contingency payments (negotiated directly with the convert holders) each year to keep the converts outstanding. This will result in 1) higher interest costs and 2) a higher tax rate (tax rate was high 30’s before the convert was issued…..co gets a tax shield based on amortizing the OID). Additionally, the company’s creditors will likely make the company uses some of its cash to pay down these converts.
$847M convert due 2/31 putable feb each year
$727M convert due 7/32 putable august each year
- Street EPS estimates too high:
o The net of lower revenues than the street has modeled, the higher interest costs from the convert, higher tax rate (35% vs 33.5%) and lower operating margins gets me to $2.40 in 2009 eps vs. the street at $3.08
- Global ad agencies are trading at 7x eps (WPP LN, PUB FP, HAV FP and IPG). Putting a 7x multiple on my $2.40 estimate for OMC gets me to a sub $17 stock vs current at $28.25, or 35%+ downside.
- Advertising industry has been coming to a screeching halt lately. I have several contacts at major agencies as well as in advertising departments at networks confirming these trends.
- During OMC’s Q3 conf call management said that the only clients cutting back spend so far were retail and auto….others were just cautious. Incrementally, things are substantially worse since they reported.
- Auto = 14% of revues and their largest customers is Daimler (3%). In the event an auto bailout does not happen there will be a big receivable at risk.
- Company has stopped its share repurchase program (last qtr approx 40% of eps growth was from equity shrinkage)
- Sales cycle expands by 2-3x (3 months to 6 to 9 months) at least in a weak environment
General:
- founded in 1986
- largest agency holding company in the world
- $12.7B in global revenue
- 2,500 agencies in 120 countries
- 3 flagship agencies are BBDO (17k employees), DDB (14k employees) and TBWA (11k employees)
- 5,000 clients
Management:
Pres / CEO – John Wren – held title since 1997
CFO – Randy Weisenburger – joined in 9/98….prior was founding member of Wasserstein
Margins and Rev growth:
- at 11.4% margin and -5% organic growth get to $2.50
Margins Rev Growth (organic)
98 13.1% 15.9
99 14.1 14.1
00 14.3 16.6
01 14.1 8.5
02 13.1 2.8
03 12.7 4.6
04 12.5 6.6
05 12.8 7.3
06 13 7.6
07 13.1 7.1
08 ?
Rev Growth (total)
Tot US UK Euro RoW f/x added
Q3 07 11.3 11.8 7.4 14.8 17 19.5 3.6
Q4 07 14.7 12.7 9.5 6.7 15.6 24.3 5.0
Q1 08 11 12.5 7.6 5.2 21.9 23.9 5.1
Q2 08 14.9 11.2 5.5 -0.4 19.6 28.8 5.2
Q3 08 11.3 6.9 3.8 -4.3 13 18.3 2.1
Clients:
- 5,000 total
- 100 largest = 46% of total
- Top client = 2.8%
- Key clients – consumer staples (Pepsi, Bud, Unilever, Nuetrogena, Gillette), Auto (Daimler Chrysler), financials (BofA, Visa) and tech / consumer discretionary (HP, Apple, BestBuy)
- Lost Dell and AT&T wireline accounts in 3q ’07 and is cycling against
Contingent convertible notes:
- $2B worth with maturities 20313, 2032 and 2038
- First Liquid Yield Option Notes (LYONs)
- 0% coupon and 0% ytm
- OMC gets tax benefits on accreted interest
- OMC typically offers holders sweeteners thru interest payments to keep them outstanding
Revenue Breakdown
Geography Discpline
US 53% Traditional media advertising 43%
Euro markets 21 CRM 37
UK 11 PR 10
Rest of Wrld 15 Specialty communications 10
Debt:
$3.2B in total debt
$2.04B converts put date
$847M due 2/31 feb each year
$727M due 7/32 august each year
$467M due 7/38 june ’10, 13, 18, 23 then every year
$51.50 - $55 conversion prices
Sweeteners past few years 2.5% in 7/08, 0.9% on 2/08
$1B senior notes
$113M drawn on credit facility
$2.5B committed credit facility expiring 6/11 from 32 banks
Bull case:
- advertising today mostly paid on fees (based on cost + a margin) vs. historically paid more on a commission basis….so in a better position to weather a downturn
- cheap based on 5 year historical valuation range 11 – 21x, avg 17x…current 9-10x
- trend towards shifting services from traditional advertising (tv, radio) towards marketing services (PR, CRM, specialty communications)….OMC has 57% of their revenue in marketing services
- manage headcount
- delay raises
- limit incentive comp
- reduce discretionary spend
Catalyst
Catalysts:
- Estimates (top line, margins, bottom line) that are too aggressive
- Converts getting put back to the company
- Higher tax rate and higher interest costs than the street has modeled