IPG, OMC, PUB, WPP: Harder Times Ahead, But Opportunities for Growth Remain -- Pivotal Research

It39s a difficult time for the agency holding companies Between slowing underlying business growth for core clients zerobased budgeting at many of them more aggressive applications of procurementbased processes the ongoing impact on fees from transparencyrelated issues likeforlike fee compression threats of widerscale inhousing of programmatic buying slowing shifts of spending into digital media among the clients agencies service and competitive threats from IT services firms ie quotthe consultantsquot there39s not a lot of good news to point to for the sector We are evermindful of the notion that the industry has always found new ways to service existing and new clients and generate new revenues from them fragmentation of media is ongoing and requires an increasing array of services However over the past few months it has appeared to us as if the aforementioned concerns are having or are going to have a greater impact than we previously anticipated This causes us to alter longerterm growth variables incorporated into our models in a negative direction at the present timeFor a starting point we note that the fiveglobal fullservice agency holding companies the four we cover plus Havas were able to generate a 4 organic growth CAGR between 2010 and 2015 led we think by media agencies which probably represented 20 of revenues for this group with organic growth that was probably close to 10 Put differently half of organic growth during this period was due to the sector39s media agencies whose growth rate slowed during 2016 impacted disproportionately by the factors referenced above and contributing towards the group39s total 3 organic growth rate with a second half growth rate of 24 Based on our current forecasts the group will probably grow at this level during 2017 and this seems to be a reasonable baseline level of organic growth for the legacy collection of businesses that holding companies own going forwardFrom this level we think legacybusiness organic growth for Interpublic and Omnicom should be probably slightly below the average and Publicis and WPP above average primarily because of different weightings of media agencies which should still be able to grow faster than other kinds of agencies albeit at a much lower rate than in prior years We assume that IPG and Omnicom will each buy 05 incremental growth every year while Publicis will buy 20 and WPP 25 Publicis39 higher exposure to IT services via businesses associated with Sapient probably adds another quarter percent We also assume that each of the holding companies are capable of continuing to expand their operating income margins as a percentage of net revenue towards a target of 20 over many years as we think that agencies continue to retain leverage in their operating models to drive down costs for every dollar of revenue as they continue to expand Including onceinadecade downturns our assumptions yield longterm cashflow CAGRs for Omnicom of around 35 limited by its already relatively high margins against our assumed amp8211 and undisclosed amp8211 net revenue for IPG of around 4 aided by relatively low but stillimproving margins with more room for expansion relative to peers for Publicis and WPP of 60 with these latter two higher vs peers because of their disposition towards inorganic growthAs part of our revised view on organic revenue expectations for the current year we have tweaked down our expectations for IPG slightly to fall towards the lower end of the company39s 34 guidance range rather than the higher end based less upon companyspecific insights and more based upon the aforementioned industry issues Other expectations for the current year are mostly unchanged if slightly negatively skewed with growth for WPP expected to come in at 18 we expect organic growth at Omnicom to come in at 35 and expect Publicis39 organic growth to total 13 for the year with a stillnegative second quarter but improving second halfIncorporating these changes into our models we continue to rate each of the companies in the agency group quotHoldquot with slightly lower YE2017 price targets Interpublic is now valued at 25 vs 26 previously Omnicom is now valued at 71 vs 77 previously Publicis is now valued at 64 vs 70 previously WPP is now valued at 1640p vs 1770p previouslyVALUATION We value companies on a DCF basis Key variables driving valuations across the agencies include longterm costs of capital ranging from 115 to 120 WPP on the low end and IPG OMC and PUB on the high end and longterm growth rates ranging from 30 for OMC to 575 for WPP On a PE basis our valuation on each of OMC PUB and WPP equates to 14x 2017 levels while IPG39s valuation equates to 17xRISKS Agency risks relate to squeezing fees from clients competition from adjacent industries reduced competition between marketers and demand for advertising servicesFULL REPORT INCLUDING RISKS AND DISCLOSURES CAN BE FOUND HERE Agencies 71017pdfThe opinions and points of view expressed in this content are exclusively the views of the author andor subjects and do not necessarily represent the views of MediaVillagecomMyersBizNet Inc management or associated writers amp160amp160

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IPG, OMC, PUB, WPP: Harder Times Ahead, But Opportunities for Growth Remain -- Pivotal Research

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