Publicis Omnicom Groupe - financials less exciting than the impending management soap opera

Oh la la, Omnicom is to be bracketed by Publicis to become part of the greater "Publicis Omnicom Groupe" with deal to be signed in Paris rather than New York or a neutral country. Does this mean a corporate coup for the French or will the emergence of a balanced board and possible removal of Publicis's voting restrictions mean that its ambition will ultimately be its undoing? From what has so far leaked out with regards future management structure, it does not look like a viable longer term proposal, with the enlarged group(e) managed out of both NY and Paris and with a head office in the Netherlands. Perhaps they will go down the Reed Elsevier route and have a dual listing as well, in order to secure their borders from too much Franglais.  It is worth noting however that the original dual management structure at Reed was a disaster and soon dropped; something that will inevitably happen here if adopted unless it is to become a mongrel.

From what we know so far, the enlarged group(e) will reflect an approx 50:50 split between Publicis and Omnicom.  Surprise, surprise, but this is broadly where the respective market capitalisations are already.  Can you imagine the feverish activity as both shares were rising ahead of this announcement the secure this or perhaps we are expected it to be merely fortuitous.


On an EV basis, Omnicom's net debt position v Publicis means that it will be the larger of the two group(e)s going into this 'merger' at around 52% of combined EV


So far we haven't seen much in the way of financial implications of the merger beyond an expected cost synergy of $500m. In the context of around $25bn of consolidated revenues this is about as spot on to my estimate yesterday of a 200bps margin benefit as one might expect some corporate planner also putting his finger in the air to come up with a figure that might impress markets.  What we don't know at this stage however is the level of dislocation to staff and clients this may also bring and the level of revenue leakage one should also be factoring in. For such a big deal, with so much potential for dislocation, this is not that exciting given the pop in both share prices in the run up to all of this. At least the impending soap opera of corporate manoeuvring and back-stabbing between NY and Paris should provide some more excitement!


Is there a winner from all of this?  Well the bankers and advisors of course. Shareholders of Omnicom will probably see their valuation in terms of growth rating back to where it started (posted savings) while Publicis's rating should drop by around 100bps to around +3% CAGR. Omnicom shareholders may consider this as the cost of not chasing after digital acquisitions earlier while Publicis shareholders may wonder whether the dilution in growth rating merely reflects the reality of the situation.






from wyt-i.com

Omnicom & Publicis – a marriage not made in heaven

Business struggles to deliver above market organic growth and therefore resorts to sector consolidation to cut costs and obscure the maturing growth profile. It is a well enough used stratagem.  Pharma has been there and done it, Telecom consolidation is currently in full flood and once again, major consolidation is being proposed in the marketing services segment with Bloomberg’s supposedly authoritative news on Friday of the advanced merger negotiations between the number two and number three agency holding companies, Omnicom and Publicis. 

At first glance such a combination may seem a value enhancing, if somewhat unimaginative plan.  In media, where scale really counts, the combination would combine three strong media networks, equalling WPP, but with more clout with approx. 40% market share vs WPP’s c. 32%.  While the core creative and media networks would be largely retained to avoid too much revenue leakage from the inevitable client conflict issues (eg with both Pepsi and Coke), there would be scope for sizeable cost savings and back office (including technology) efficiencies.  As a rule of thumb I would expect at least +200bpts to net operating margins over the initial 3 years (net of revenue leakage) with after leveraging thru debt and tax benefits could be raising earnings by around +20% over the same period.  So what’s the problem?

Barring the possible anti-trust issues, particularly in the US (see above chart), this story/deal smells fishy.   This is being touted as a merger of equals, but has anyone pushing this story ever actually worked for a French national champion?  Is this the same company (Publicis) that accepted the resignation in 2010 of the CEO (David Kenny) of its then US digital prize, Digitas, because he was not able to relocate to Paris? Is this the company with a restrictive voting structure and a decidedly Gallic flavour to its supervisory board which includes the daughter of the founder as Chair and two of his grand-children and an executive board headed by the archetypal suave Frenchman, Maurice Levy from his offices overlooking the Arch de Triomphe?

In addition to the inevitable cultural clash, the strategy embarked by each group has also been very different. Omnicom has eschewed large acquisitions while Publicis has aped WPP with a spectacular pace of corporate expansion, particularly with its recent digital acquisitions.  If Publicis still believes that these will deliver the growth and returns, why is it selling out on a nil premium merger basis to the Americans who have invested less in these tools and services? It is not as if Omnicom would provide a significant advantage in geographical coverage or exposure in growth markets given both companies heavy exposure to the US.  If Publicis was just after a third media network and more Asian exposure, it could have always have pursued Aegis again, which it didn’t.   If Publicis is seriously selling out control at this stage without a significant control premium it should sound a warning claxon as to what they know that markets don’t.  Has there been a dud or two amongst its vaunted digital acquisitions that is going to bite them where it hurts?

A brief history of these groups by charts

1   1)      Touted as an above growth segment, agencies have failed to deliver above GDP rates of organic revenue growth, notwithstanding the network benefits of folding in acquired new skills. Since 2000, there really has not been much to separate the top 3 players (WPP, Omnicom and Publicis) in terms of cumulative organic revenue growth; all of which have substantially lagged cumulative Global GDP. So much for the organic growth story! 

       2)      Margin expansion. If you can’t out-grow on the top line, try to make up the slack on the bottom line. The first stop of course is EBITA margins (then capital structure and tax). Downward pressure on gross margins from clients however makes this tough to achieve, particularly if you have to invest (internally) in new service development. No problem, just buy in these skills with acquisitions where the previous development spend will sit unamortised on your balance sheet as an intangible. As investors tend to exclude the arbitrary amortisation of acquired intangible, this provides a free get out of jail card while stripping out overlapping operating costs to deliver on the margin story.

3    3)      Not-withstanding all this, the ‘underlying’ EBITA story is not particularly impressive with only Publicis running ahead of GDP. But with enough financial leverage, falling interest rates and all that US tax relief on acquired intangibles, the sector can deliver what the market thinks it wants and thinks it is getting, above market EPS growth.  With multiple of billions of £/$/€ of acquired intangibles on each group’s balance sheet however this is somewhat of a moot point. How much of this is really being consumed is tough to calculate, but even a 15 year amortisation could more than halve the perceived returns of some of the groups. Well worth remembering when someone tries to flog an earnings based valuation to you.

  

4    4)      Acquisition ROI? Although the below table does not attempt to apply an amortisation for consumed acquired skills and services (intangibles), the implied pre-tax returns do not suggest either significant growth from acquisitions unless the core businesses are in decline. Having spent least on acquisitions, the implied real ROI by Omnicom heads up the pack with both Publicis and WPP languishing at only around 8% if one assumes an inflation adjusted  market average growth of +2% pa over the period (15 years).  

Valuation by growth rating – added without comment or recommendation

 

 

Informa starts clearing the decks ahead of new CEO arrival

A Friday announcement ahead of a sunny weekend and in the middle of the results season and school holidays is usually a good time to dribble out some news that you don't want attracting too much attention. So today we have the announcement by Informa that it is dumping 5 of its training businesses for between £104-113m (contingent of future returns), albeit with approx £41m ($65m) of this provided by Informa with a loan at only 1% (at least for the first 2 years).

So what are the valuation metrics behind this sale. The businesses made £14.8m of EBITA last year on revenues of £122m, so an EV/REVS multiple of 0.9x for a 12% margin. The exit EBITA yield of between 13-14% meanwhile should provide a good cash flow positive enhancement for the PE buyers (Provident - no kid!), particularly given that around 40% of the purchase price is being funded by the 1% loan from Informa itself (OMG how desperate are these guys!) .  Even assuming a possible 100% EBITA to operating cash flow conversion and a 30% normalised tax rate and the exit Op FCF yield (post tax) is still a whopping 9-10%. Not bad for Provident, although it would still need the business to be able to generate trend growth of at least +1% pa. Perhaps Informa knows a little more about the prospects.  It certainly going to take a sizable hit on its balance sheet as these businesses were sitting on the books at £226m, so expect a -£22m impairment.

While markets are being trained by financial repression to go for yield, it is good to see that returns are still defined by growth and risk.  Informa, for whatever reason, has now decided to kick a low growth/quality business out of the door and take the earnings dilution hit because it understands the valuation issues.  One has to wonder however given the stalled organic growth across the growth how many more such businesses may remain in the portfolio and whether the valuation for the group as a whole should be parameterised by its ability to deliver on this implied growth.

Without comment or recommendation is some possible pertinent analysis of implied growth ratings.

Chilly without Carney or just burn baby burn?

Before we all get bogged down in the Q2 results season which is beginning to gather pace I think it is good to remind ourselves of one part of the financial burden that is to crush us if interest rates rise to more normalised levels - that is the scale of Govt, household and non-financial debt facing us all. The maths is fairly simple. For an economy with gross debt equal to GDP (ie 100%), every 100bps rise in interest is an immediate drag to growth of 100bps. In reality the impact is considerably greater given the multiplier effect.  Rates as we can see below are already rising from their QE manipulated troughs. Bernanke may squeal that it was all a great misunderstanding, but the cat is out of the bag. Big bond fund managers are trying to goad you into these current yields as a buying opportunity, but without Fed support a return to 4-5% is not impossible. 

A potential +200bps rise, even if over a 2-3 year time frame on many of the Western economies with total non-financial debt running at 250-300% of GDP 'ain't goin to be pretty'. Do the maths. The direct impact alone will be around -1% pa from average GDP growth. Competitive devaluations aside, the recent upgrading of UK GDP expectations by one big bank (from +09% to +1.1%) must take the biscuit as one of the pointless revisions. Yes we are all sensitive to directional changes, but what's the margin of error on these forecasts? I would judge at least +/-50bpts. If this is just a big suck up to new wunderkind at the BoE, Mark Carney, to endorse his new open policy of 'guidance' (aka "Spin"), then this is about as worthless as taking seriously the shifting prognostications of his counterpart in NY.  Better to look to who appointed Carney, (Osborne) and what his agenda is. Approaching what could be this Govt's last General Election and with support shredded by UKIP, the Chancellor is now desperately resorting to Bush senior's epitaph "read my lips, no new taxes" with his own version of "no tax increases to eradicate the deficit".  Bollocks!   On the Govts previous projections which included a miraculous recovery in GDP they were still running a sizable deficit by the end of this Parliament and if rates rise the rate of deficit reduction is going to be even less than this forecast. So if Osborne isn't going to raise taxes (well he might, but just claim these are for improving hedgerow and rural wildlife) and the economy can't be trusted to deliver, then he will have to sell more debt. His quandary however, is that if he tries this while the Fed is 'tightening' (or less easy), then rates will have to rise and he can kiss goodbye to ever getting re-elected. His good buddy Mark Carney whom he personally selected is going to do what? Sit there in sympathy while have Milliband around for tea or do a Bernanke. 'Print baby print' and then head home to Canada before the shit hits the fan? You work it out.

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More muppets needed

Benanke does some back-peddling on tapering and we're back to the 'good' times again. More easing of course spells a weaker dollar, which after its recent surge, was ripe for some profit taking. On the other side of this trade,  equities and commodities rose, including at last gold.  - nice to see life is now back to its simple rules again and is being bounced around by the apparently inconsistent spinning of one man!

But hang on.  What about June's supposedly stellar job growth numbers. Surely this points the trajectory closer towards the 6.5% unemployment target and the end of QE given the Oracle's guidance (spin) for US GDP growth to accelerate to +3-3.5% next year. No problem, Bernanke is making it plain that one should check carefully for wriggle room in the fine print and that the 'target' was merely a threshold and definitely not a trigger. Also, he is keen to stress that he remains accommodative in keeping interest rates low and that possible tapering should in no circumstances be misunderstood as meaning actual tightening.  Blah, blah and blah!  (translation: Buy suckers!)

A rise in rates and a stronger dollar however would mean that asset price increases and the property revival that Bernanke has been using to engineer the recovery would stall. He still needs the muppets to keep buying and he is well aware that his mouth is the real policy tool.  

Pressure is building for capital markets to return to a market driven pricing of capital and risk and the addict must at some stage be weened off its unhealthily dependency on cheap money, at least for the banks. The problem however is that this is a very painful process. For some, the rise in rates will be devastating and it may well be that we have already passed the point of no return.  Does anyone really know what sort of shit remains lurking on the 'books' for the banks. I do not use 'balance sheet' deliberately, as the recent exposure that Deutsche Bank has been hiding some bad stuff from Brazil off balance sheet shows how little one can still rely on their published accounts.  Clearly nothing has been learnt! Banks pass 'stress tests' then collapse (remember Bankia) after suckering in another bunch of muppets.

For the past four years, banks have had access to almost 'free' money from central banks. Have they used this to repair their balance sheets and restore funding for industry?  No, the supposed balance sheet repairs have largely been done for them by their central banks pumping up the asset boom while corporate lending is focused at the larger end, leaving many SME's still starved of capital. So where has all this hot short term money gone? Asset speculation and of course sovereign debt purchases seems to be the answer.  Central banks needed banks to help buy the debt that their Govts needed to sell to fund their unresolved deficits - in Europe, the ECB's possibly unconstitutional OMT is an extreme example of this. While central banks crushed rates, this was party time for the chosen few with access to cheap money.  They borrowed cheap and short and lent higher and much longer, not only to take the rate mismatch as income (yes, that's where the 'profit recovery' that has supported the rally in bank shares has partly come from), but also to book the capital appreciation of the bonds already bought.  This however is not arbitrage but merely another carry-trade which carries a potential time bomb of duration risk.  As long real rates go negative and a supposed economic recovery removes central banks as the marginal buyer of all that debt which Govts still need to sell to fund their unresolved deficits, what happens next could be very ugly.  Short term rates could rise to more than the yield of recently bought long bonds which would make the carry trade actually cash flow negative. A rise in the long end could also precipitate massive capital losses on the Govt debt that all these banks have been encouraged to purchase. If this is to be painful in the US, just think what damage it would do to European banks (eg Spanish) whose books are full of the stuff. As the bounce in recent 10 year yields in Portugal demonstrate, the potential rebound in yields can be much greater and faster than expected and that after years of central bank coddling, we have become increasingly complacent to the risks.  Even in the US, when 10 year rates 'soared' to 2.5%,  there was no shortage of talking heads advising us that this was a great buying opportunity. Quite why a probably sub inflationary return from a bust Govt in a global market flooded with liquidity is supposedly a great buying opportunity beats me. Unless of course you run a bond fund or need the muppets to take the other side of your trade as the banks see the writing on the wall and start to bale out!

So where do I think we are?  QE has not delivered the self-sustaining recovery and is increasingly becoming the problem rather than the cure. Govts seem incapable of tackling their structural deficit issues and QE fixes merely encourages politicians to defer the solutions.  At some point the patient has become an addict. Do you let him go through cold turkey (ie let asset prices and money find their true market values) or keep feeding his habit until he dies? Unfortunately I see no evidence of resolve from politicians who have nurtured a majority of the electorate to be state dependents. Short term however, there may finally be an appreciation from at least one central banker before he retires to steady the ship and so provide some defense for his legacy and ahead of what is to come.  He has to initiate a policy to end QE, but he can't afford for markets to get spooked and unwind the asset inflation that he has supported, hence the laboured attempts to soften the blow with recent dovish commentary. If real rates are to rise however, real asset prices may need to fall, particularly at the long end of the bond market.  Banks who have built up sizable holdings of the stuff though also control the Fed, so expect more dovish spin until at least they have unwound their positions. Now about the muppets..............

US jobs growth in June - headline beat misses fall in full time jobs

Hurrah for the recovery in US employment!  June’s +202k increase in private sector jobs was ahead of ‘expectations’ and have been spun as a further confirmation of the self-sustaining recovery in the US economy and the planned ‘tapering’ of the Fed’s current $85bn per month of QE life support.  As a consequence the US dollar has been rallying and perhaps perversely even US stock prices notwithstanding the creeping up of long bond yields and probably with more to come.

June’s jobs data may have been an improvement, but the underlying  picture remains bleak. Year on Year, the increase in private sector jobs was a mere +1.8%; little more than the overall increase in working age population.  True, average weekly wages are up around +3.2%, which indicates gross wages from the private sector are up around +4.6% YoY and +$215bn annualised. Strip out the +$120bn YoY increase in annualised Federal personal tax receipts however and the post tax increase in personal income was only around $96bn or +2.7% YoY. Hardly the stuff of a booming economy when ones trading partners are grinding to a halt and a rising dollar is eroding competitiveness!  Add in the supposed stimulus of Bernanke’s $85bn per month QE programme and the rising in private sector income is little better than horrendous.
 

 The mix of new job creation meanwhile also provides cause for caution. If industry believed in the sustainability of the recovery, then one would expect a shift towards full time job creation. This is not happening and June’s buoyancy in private job formation was entirely as a consequence of part time job group as full time private sector jobs fell by -240k in June.  Again, this is hardly the stuff of an imminently surging economy.  A moribund global economy and a strengthening dollar suggests against an export led recovery. A consumer led recovery however will need rising disposable income or a run down in savings. The dearth of full time ‘quality’ jobs and rising interest/mortgage costs must now make this increasingly unlikely.

So where does this leave the US?  The Government, like virtually all others, has eschewed tackling its structural deficit. Its central bank has swallowed around $1tn pa of this through a QE programme that has bought time for the Government but with little tangible to show in terms of real and sustainable economic growth. If growth stalls, as is likely, then the deficit hole just gets bigger as the politicians have shown little appetite for taking hard choices. If the new Fed chairman is not there to buy back the bonds that will have to be issued, then rates will rise, and possibly rapidly, which will crush the consumer and all those piling back into cheap financed properties.

The Government (collectively) is not prepared to live within its means and as always will take the line of least resistance (yes this is what got the Greeks in trouble, but who cares).  Obama cannot afford to allow interest rates to rise, but won’t cut expenditure.  He needs cash for ‘his stash’ to reward voters and protect his legacy and will therefore appoint a replacement to Bernanke who will keep the printing presses rolling.  My tip for the job will be his trusty ex Treasury Secretary, Tim Geithner.

Original post on www.wyt-i.com on  9 July 2013

Bernanke blowing bubbles

“I don’t see much evidence of an equity bubble” Ben Bernanke, 26 Feb 2013

Give the man credit, he did manage to keep a straight face when he blew this bubble while pumping an additional $85bn per month into the financial system and pursuing an unprecedented policy of financial repression to force the muppets up the risk curve just ahead of calling the end of the party. Ouch!

Perhaps Kermit should have paid heed to this earlier pearl from the professor - “The Federal Reserve is not currently forecasting a recession” Ben Bernanke, January 2008.   This is not to suggest that the Fed Chairman’s ability to anticipate changes in economic trends is rubbish, but that like the oracle in Matrix, he tells us what he feels we need to believe.  (A well-worn weapon up any central banker’s arsenal  - see note*1 below)

So what are markets to make from ‘Bubbles’ Ben’s latest bit of news manipulation?  Having dribbled it out the possibility of an earlier than expect end to QE to the usual market “sources”, he now appears to have confirmed the “tapering” stories. The official line is that QE has been such a success, that the rate of asset purchases can now be reduced by the year and assuming the rather important caveat of a highly ambitious ‘real’ GDP growth forecast for 2014 of +3-3.5%, possibly ended entirely by this time next year.   So well done ‘Bubbles’, you can now safely retire at the end of you current term in January 2014 (and helpfully confirmed by President Obama) knowing that the US economy has been restored to self-sustaining growth.

Unfortunately, the numbers do not support such a Panglossian interpretation of recent history or forecasts of sustained recovery.  As such, the recent events seem more to be part of an exit strategy. What is less clear however at this stage is whether it represents an escape route for the man or a more fundamental recognition and refutation of what to many has become a highly damaging strategy to the whole bedrock on the capitalist system; the market pricing of risk.

Item 1: QE – has it worked?  To justify fiscal stimulus, Keynesian economists tend to over-state the expected returns from increasing government expenditure (to soak-up excess capacity during recession - the expenditure multiplier), knowing that validation post-event can be obscured by the usual “what-if” arguments.  However, for the US Govt  to reflate significantly faster this time, yet experience a commensurately weaker recovery presents an obvious problem.  If one were to take seriously the recent IMF study suggesting a fiscal multiplier was as high as 1.7x for the 28 economies it surveyed during the “crisis years of 2010-11”, then how are we to reconcile the simple maths of US GDP lagging the growth in Govt debt. Since the economic trough in 2009, US nominal GDP has increased by only $2.1tn, an average CAGR of only +3.6% pa.  Federal debt however has increased by 3.5 times this amount over the same period and by over $7tn.
  

On any analysis, this sucks, with every $1 increase in Federal debt being accompanied by only a 40c rise in nominal GDP.  Add in the tail wind that a 2-4pts reduction in key interest rates over the period on household debt (100% of GDP in 2009, nearer 85% now) and Federal debt (now >100% of GDP) should have delivered and perhaps the IMF’s original fiscal multiplier premise of only 0.3x was nearer the mark – a fiscal divider?

As well as depressing ‘risk free’ returns and driving up risk asset prices (to bailout the banks), let’s not forget that QE has also been directly funding a substantial portion of the Govt largesse (ie to bailout Obama); increasing its balance sheet ‘assets’ by over $2.1tn at a zero initial funding cost. Even assuming a fiscal multiplier effect on this alone, would more than halve the already anaemic rate of GDP growth in this recovery to well under +2% CAGR; ie little more than real inflation.

The inescapable conclusion?    US Govt expenditure increases and associated QE support has failed to demonstrate a fiscal multiplier of over 1x; indeed given the distortions to pricing market risk, QE may be becoming the problem rather than the cure as corporates continue to sit on investment.  Generating the political will to kick the QE habit however will be very difficult.  QE tapering, let alone reversal, would inevitably return interest rates to more normalised levels unless accompanied by credible plans to tackle structural Govt deficits.  With headwinds also coming from slowing growth in China, competitive Japanese devaluations and continued recession across the EU, next year’s GDP growth targets look vulnerable and therefore could provide the all-too-easy get-out clause to resume QE and attempt to kick the can back down the road.  Ultimately this remains a political issue. Will electorates support responsible policies to fund their deficits or again bequeath these to future generations as a politically expedient policy to secure re-election. Unfortunately demographics is working against a fundamental resolution. We all know the madness of Greece, as irresponsible Governments were re-elected on promises that could never be kept. Unfortunately that seems an inevitable consequence of when there are more people voting for a living than earning one. In this regard the trend in the US is not favourable.   Private sector employment into the supposed recovery is increasing at no more than the overall growth in working age population notwithstanding the scale of fiscal stimulus.  Longer term however, the trend is clear, the private sector is representing a diminishing proportion of  the economy and is now the minority, but still supporting the majority.

Note:*1  “Blah, Blah Blah”  remains the central bankers  weapon of choice.  Although my point is perhaps not as studiously made as by Michael Woodford (see NBER working paper 15714: Simple analytics of the Government Expenditure Multiplier – http://www.nber.org/papers/w15714), the antics of this bunch of neo-Keynesian diehards has done little to convince investors that markets have become no more than casinos geared towards front-running the next, but increasingly threadbare statement from Bernanke, Draghi et al.


original post on 21 June 2013 at www.wyt-i.com