Publicis: Not-So-Bad 2016 Ahead -- Pivotal Research

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Publicis reported its 1Q16 results today. As with last quarter’s results, the headline organic growth rate was substantially above expectations.

Publicis reported company-wide growth of +2.9% on an organic basis during 1Q16, once again substantially above consensus views that were muted given negative considerations constraining the company in recent periods. Europe, North America and Asia Pacific regions all posted better rates of growth (at +3.4%, +3.0% and +3.8%, respectively), with Latin America a drag at -3.1% with Brazil and Mexico down significantly (-9.5% and -14.6%, respectively). The quarter will be viewed favorably by investors, many of whom were essentially writing Publicis off in recent periods.

Among the factors supporting the quarter’s outperformance was the retention of revenues from clients who have already announced plans to change agencies but who have not yet completed their transitions. As well, the Sapient business returned to >+10% growth during the quarter after a slowdown followed by declines between the end of 2014 and the first part of 2015. As these revenue streams would have represented around 10% of the quarter’s revenue for the whole company, this outcome probably added +1% to the company’s organic growth (which we think is illustrative of the potential for Publicis to outperform its peer group over a mid-term time horizon).

Management indicated that the company’s relatively new principal trading operation Apex – which, according to a report published in Ad Age yesterday presently employs “about 25 people” and is transacting with traditional and digital media alike – was not a meaningful contributor to the quarter’s results. We note that there is potentially significant upside to reported results in gross revenue terms per employee, if not in operating income from such a business if advertisers embrace it. Our guess is that Omnicom’s equivalent entity Omnet is probably contributing hundreds of millions of GAAP revenue (and possibly significant operating income) to that company barely more than two years after that unit began operations. The downside risks are that clients come to associate such activities as creating previously under-appreciated conflicts-of-interest between those of the marketer and the holding company.

Much of the discussion on the earnings call related to efforts to integrate Sapient into the broader organization, which the company is clearly focusing on. We are strong believers in the role that marketing technology plays in marketing services now and for an extended time horizon into the future (thus our coverage of Adobe and within our coverage universe). However, the degree to which Publicis’ legacy agencies can cross-sell business transformation and marketing technology implementation services – especially via consulting activities, rather than “only” the digital creative and digital media activities that creative and media agencies conventionally sold in recent years – is not without challenges and remains an important point to monitor. If successful, Publicis’ business mix is positioned for longer-term outperformance vs. its peer group of agency holding companies.

In terms of forward-looking financial results, management indicated it expects the outcomes from last year’s media reviews to negatively impact the company’s results in the second and third quarters vs. what occurred during the first quarter, with a -1.5% full year headwind for all of 2016. However, even with these expectations, management’s 2016 outlook is unchanged – optimistic, but cautious. Longer-term financial targets are unchanged. Our own operating model is adjusted slightly upwards as we now forecast +2.6% organic growth vs. +2.1% previously.

We continue to view Publicis favorably at current levels. Post these results, we are retaining our price target on Publicis at €72 and continue to rate the stock Buy.

VALUATION. At €72, our target for Publicis is derived using a 7.5% near-term discount rate, a 11.1% long-term discount rate and a 4.25% long term growth rate. Our price target equates to a 15x P/E on a 2016 basis.

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


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