GroupM Media Agency Reorganization Reflects Industry Trends -- Pivotal Research

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WPP's GroupM has announced a partial reorganization, combining global media agencies Maxus and MEC and establishing digital agency Essence as a new fourth pillar for GroupM. Both are notable to the extent that they represent the need for scale to drive ongoing margin improvements and the need for differentiation to drive longer-term organic revenue growth. Overall, the news is neutral for WPP stock vs. prior expectations, but ongoing developments in media agencies remain as important ones for investors to monitor given the critical nature of media agencies to their holding company parents. We continue to rate WPP Hold with a 1780 YE2017 price target.

Media agencies are generally the most important business units of global agency holding companies, as they typically represent the bulk of organic revenue growth and profit expansion produces. Thus, industry pressures which disproportionately impact media agencies are important to monitor. The presence of zero-based budgeting and/or the fear of activist investors who might push marketers to reduce costs loom large as facts of life for agencies. Commoditization of services doesn't help, with most global media agency networks indistinguishable to all but the most seasoned of practitioners. Media contract transparency issues remain top-of-mind issues and present ongoing headwinds. In-housing of programmatic media buying – or otherwise more involvement from marketers in vendor selection and process management in this space – is another drag. Further, opportunities from incentive-based compensation are probably ephemeral, as marketers would generally prefer to reduce absolute compensation to their agencies. There are saving graces, as some marketers exhibit a willingness to allow their agencies to engage in higher-margin arbitrage based activities and as most marketers end up requiring agencies to help manage a highly fragmented, constantly evolving media industry, enabling opportunities for agencies to produce revenues from yet-to-be-benchmarked and still opaquely priced services.

With this context, we note today's announcement that WPP's GroupM media agency division is reorganizing in part, combining two of its main global media agencies businesses, Maxus and MEC, and enhancing the position of the recently acquired Essence.

For Maxus and MEC, two networks with different and mostly successful histories, but ultimately similar businesses (with MEC rebounding from last year's AT&T loss and Maxus striving to establish a global client base), the combination produces what will now be the world's third largest standalone media agency by headcount after Omnicom's OMD and Dentsu's Carat, on data from industry tracker Comvergence. This should support enhanced operational scale (which is to say higher margins) and a similar organic revenue growth profile vs. leaving the businesses as stand-alone entities. For Essence – acquired in 2015 – this appears to represent an effort to firmly establish a business best known as Google's media agency as a new fourth and relatively differentiated pillar of GroupM, alongside the combined Maxus-MEC, Mindshare and Mediacom. To the extent that Essence is provided with incremental resources and internal investment, retains existing management and adds others, Essence should be able to establish itself as a competitive alternative in increasing numbers of regional global media pitches, and continue contributing towards GroupM's overall growth. Differentiated positioning is going to be increasingly important for every media agency division, given the successes of Omnicom's Hearts & Sciences (with AT&T and P&G wins in the United States in particular) and what we think will be an improved position from Publicis' media agencies as competencies associated with Sapient are embedded in those businesses over time.

Overall, the news is neutral for WPP stock vs. prior expectations. Ongoing developments in media agencies remain as important ones for investors to monitor given the critical nature of media agencies to their holding company parents. We continue to rate WPP Hold.

VALUATION. We value WPP's business with a DCF framework, incorporating a 7.5% near-term discount rate, an 11.5% long-term discount rate and a 5.0% long-term growth rate.

RISKS. Agency risks relate to blowback from the transparency issue, squeezing fees from clients, competition from adjacent industries, reduced competition between marketers and demand for advertising services.

FULL REPORT INCLUDING RISKS AND DISCLOSURES CAN BE FOUND HERE: WPP 6-1-17.pdf

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