Description

Founded in 1926, Publicis is third largest communication and marketing groups in the world, after WPP and Omnicom.

Founding family heirs are still on the Board but all have careers outside Publicis, and have insignificant % of the company. Maurice Levy, ex-CEO and Chairman has a firm grip on the company and works alongside his handpicked CEO Arthur Sadoun.Variable compensation is tied to organic growth + operating margin, relative to the results of peers (OMC, IPG, WPP).

Previously Publicis was mainly a holding company, being an umbrella for numerous companies, providing vertical integration. But lately, specifically in 2016 onwards, a more profound centralization is happening under the term „Power of One“, where they moved away from being a holding company to being a platform offering a one-stop solutions to customers.

In 2014, Publicis acquired Sapient, its largest acquisition to date for $3.7bn. Sapient is a digital consultancy company, meaning a whole new direction for Publicis. Publicis paid 44% premium for it and in 2016 wrote down half of it. Multiple paid was 12x EV/EBITDA on FY1 estimates at the time. Investors were flabbergasted with the acquisition, not understanding exactly how Sapient is fitting the portfolio of Publicis. Sapient is basically a digital consultancy which brings the company to the digital age. Builds website, buys and sells ad-space, creates these ads and creates the e-commerce side of the business. Accenture is somewhat a peer to Sapient.

In 2019, Publicis acquired Epsilon from Alliance Data Systems, a technology and platform company focusing on maximizing the value of its clients data. Epsilon generated $1.9bn of revenue, 97% of it in U.S. Net consideration of $3.95bn, 8.2x multiple on 2018 adjusted EBITDA of $485m. Transaction to be EPS (12.5%) and FCF per share accretive (18.3%). Financed with cash on hand and debt. Net gearing is now 75% with net debt/EBITDA at 2x. Management has vowed to deleverage fully within 4 years.

Epsilon was transformational deal for Publicis for 2 reasons. 

1. Integrating first-party data into advertising bundle. Publicis is now able to offer a one-stop solution for its customers. Besides legacy creative/media planning services, they also offer digital consultancy services via Sapient, and also data insights into customer behaviour via Epsilon. This already started bearing fruit as they have won numerous new engagements in 2020 due to Epsilon.

2. Investors still view Publicis as a disrupted ad agency business, assigning terminally declining business valuation. Meanwhile 50% of the revenues are no longer related to advertising. This signficantly alleviates the previous terminally declining arguments.

Publicis has historically had an overweight exposure to FMCG sector, which was/is going through a cyclical/fundamental weakness in their products, losing market share in lots of categories to start-ups, catering to millenial generation. This has weighted on Publicis organic growth numbers, trending below main competitors.Similarly, the whole Group has re-rated lower due to the rise of digital advertising. Fall in TV/radio/newspaper advertising has burdened Media planning arms of agencies, and decreased their relevance. 

After the recent rally in market, risk-reward has changed considerably. 3Q results came strong, only lagging IPG. Market has rewarded IPG and Publicis, with these 2 significantly outperforming the other 2 on a YTD basis. We believe relatively strong 3Q was due to the Epsilon addition.

On a forward basis, we further expect Publicis to outperform peers, closing the discount gap in multiple. EV/EBIT graph is similar.

Company has a stable FCF generation capacity. The chart doesnt include Sapient and Epsilon acquisitions. Historical FCF yield has been ranging from 7-10% with last couple years slightly above at 11-12% (on equity). Company has also been stabily paying dividends, at 2-3% yield.

I value Publicis using DCF. Assumptions - 2019 FCF declining by 2% p.a., 7.31% WACC, -2% perp growth. Implies a ~55/sh valuation, 34% upside to current price. Sensitivity to various growth rates below. This all assumes 7.31% WACC is fair.

The thesis is two-fold here. Investors will notice good relative organic numbers flowing through, closing the valuation gap with peers. Since company doesnt report figures by segment, no one really knows what's the breakdown on revs/ebit, what is driving organic growth and so on. This opaqueness makes investors brush it with a broad stroke and disregard looking beyond headline figures.Second is a bit more up in the air and that is that agencies will adopt to ad spend moving digital and start providing value-add expertise to advertisers. This will re-rate the whole group and isn't Publicis specific. But I wouldn't rely on it alone, without a significant discount to valuation as this is basically investing into melting ice cubes.

Even if both of these will be proven to be wrong, the valuation offers a high margin of safety, thus limiting downside. 

Fun fact. In 2012, after WPP's famed founder Sir Martin Sorrell posted an article in FT (https://www.ft.com/content/ea12c3e6-aeee-11e1-a8a7-00144feabdc0), he received a phone call from Warren Buffett, offering to buy WPP at 16% premium, ~10x FWD P/E. If we assume Buffett offer extends to Publicis currently, that would value Publicis at 47/sh. 

Catalyst

1. Strong relative organic sales growth in the next quarters

2. Change of investor perception on advertising agency model